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SYSTEM AND METHOD OF MARGINING FIXED PAYOFF PRODUCTS
REFERENCE TO RELATED APPLICATIONS
[0001] This application claims the benefit of the filing date under 35 U.S.C.
119(e)
of U.S. Provisional Application Serial No. 60/608,736 filed September 10,
2004, which is
hereby incorporated by reference.
[0002] The following co-pending and commonly assigned U.S. Patent Application
has
been filed on the same date as the present application. This application
relates to and
further describes other aspects of the embodiments disclosed in the present
application
and is herein incorporated by reference.
[0003] U.S. Pat. Application Ser. No. 11/030,815, "SYSTEM AND
METHOD FOR ACTIVITY BASED MARGINING", (Attorney Ref. No.
4672/410), filed herewith.
[0004] U.S. Pat. Application Ser. No. 11/030,796, "SYSTEM AND
METHOD FOR EFFICIENTLY USING COLLATERAL FOR RISK
OFFSET", (Attorney Ref. No. 4672/417), filed herewith.
[0005] U.S. Pat. Application Ser. No. 11/030,833, "SYSTEM AND
METHOD FOR ASYMMETRIC OFFSETS IN A RISK MANAGEMENT
SYSTEM", (Attorney Ref. No. 4672/418), filed herewith.
[0006] U.S. Pat. Application Ser. No. 11/030,814, "SYSTEM AND
METHOD FOR DISPLAYING A COMBINED TRADING AND RISK
MANAGEMENT GUI DISPLAY", (Attorney Ref. No. 4672/419), filed
herewith.
[0007] U.S. Pat. Application Ser. No. 11/031,182, "SYSTEM AND
METHOD FOR FLEXIBLE SPREAD PARTICIPATION", (Attorney Ref.
No. 4672/420), filed herewith.
[0008] U.S. Pat. Application Ser. No. 11/030,869, "SYSTEM AND
METHOD FOR HYBRID SPREADING FOR RISK MANAGEMENT",
(Attorney Ref. No. 4672/421), filed herewith.
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COPYRIGHT NOTICE
[0009] A portion of the disclosure of this patent document contains material
which is
subject to copyright protection. The copyright owner has no objection to the
facsimile
reproduction by anyone of the patent document or the patent disclosure, as it
appears in
the Patent and Trademark Office patent file or records, but otherwise reserves
all
copyright rights whatsoever.
BACKGROUND
[0010] Futures Exchanges, referred to herein also as an "Exchange", such as
the
Chicago Mercantile Exchange Inc. (CME), provide a marketplace where futures
and
options on futures are traded. Futures is a term used to designate all
contracts covering
the purchase and sale of fmancial instruments or physical commodities for
future delivery
on a commodity futures exchange. A futures contract is a legally binding
agreement to
buy or sell a commodity at a specified price at a predetermined future time.
Each futures
contract is standardized and specifies commodity, quality, quantity, delivery
date and
settlement. An option is the right, but not the obligation, to sell or buy the
underlying
instrument (in this case, a futures contract) at a specified price within a
specified time. In
particular, a put option is an option granting the right, but not the
obligation, to sell a
futures contract at the stated price prior to the expiration date. In
contrast, a call option is
an option contract which gives the buyer the right, but not the obligation, to
purchase a
specific futures contract at a fixed price (strike price) within a specified
period of time as
designated by the Exchange in its contract specifications. The buyer has the
right to buy
the commodity (underlying futures contract) or enter a long position, i.e. a
position in
which the trader has bought a fu.tures contract that does not offset a
previously established
short position.. A call writer (seller) has the obligation to sell the
commodity (or enter a
short position, i.e. the opposite of a long position) at a fixed price (strike
price) during a
certain fixed time when assigned to do so by the Clearing House. The term
"short" refers
to one who has sold a futures contract to establish a market position and who
has not yet
closed out this position through an offsetting procedure, i.e. the opposite of
long.
Generally, an offset refers to taking a second futures or options on futures
position
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opposite to the initial or opening position, e.g. selling if one has bought,
or buying if one
has sold.
[00111 Typically, the Exchange provides a "clearing house" which is a division
of the
Exchange through which all trades made must be confirmed, matched and settled
each
day until offset or delivered. The clearing house is an adjunct to the
Exchange
responsible for settling trading accounts, clearing trades, coll ecting and
maintaining
performance bond funds, regulating delivery and reporting trading data.
Clearing is the
procedure through which the Clearing House becomes buyer to each seller of a
fiitures
contract, and seller to each buyer, and assumes responsibility for protecting
buyers and
sellers from fmancial loss by assuring performance on each contract. This is
effected
through the clearing process, whereby transactions are matched. A clearing
member is a
firm qualified to clear trades through the Clearing House. In the case of the
CME's
clearing house, all clearing members not specifically designated as Class B
members are
considered Class A clearing members. In the CME there are three categories of
clearing
members: 1) CME clearing members, qualified to clear transactions for all
commodities;
2) IMM clearing members, qualified to clear trades for only IMM and IOM
commodities;
and 3) IMM Class B clearing members, solely limited to conducting proprietary
arbitrage
in foreign currencies between a single Exchange-approved bank and the IMM and
who
must be guaranteed by one or more Class A non-bank CME or IMM clearing
member(s).
Note that a "member" is a broker/trader registered with the Exchange.
[0012] While the disclosed embodiments will be described in reference to the
CME, it
will be appreciated that these embodiments are applicable to any Exchange,
including
those which trade in equities and other securities. The CME Clearing House
clears,
settles and guarantees all matched transactions in CME contracts occurring
through its
facilities. In addition, the CME Clearing House establishes and monitors
financial
requirements for clearing members and conveys certain clearing privileges in
conjunction
with the relevant exchange markets.
[0013] The Clearing House establishes clearing level performance bonds
(margins) for
all CME products and establishes minimum performance bond requirements for
customers of CME products. A performance bond, also referred to as a margin,
is the
funds that must be deposited by a customer with his or her broker, by a broker
with a
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clearing member or by a clearing member with the Clearing House, for the
purpose of
insuring the broker or Clearing House against loss on open futures or options
contracts.
This is not a part payment on a purchase. The performance bond helps to ensure
the
financial integrity of brokers, clearing members and the Exchange as a whole.
The
Performance Bond to Clearing House refers to the minimum dollar deposit which
is
required by the Clearing House from clearing members in accordance with their
positions. Maintenance, or maintenance margin, refers to a sum, usually
smaller than the
initial performance bond, which must remain on deposit in the customer's
account for any
position at all times. The initial margin is the total amount of margin per
contract
required by the broker when a futures position is opened. A drop in funds
below this
level requires a deposit back to the initial margin levels, i.e. a performance
bond call. If a
customer's equity in any futures position drops to or under the maintenance
level because
of adverse price action, the broker must issue a performance bond/margin call
to restore
the customer's equity. A perforinance bond call, also referred to as a margin
call, is a
demand for additional funds to bring the customer's account back up to the
initial
performance bond level whenever adverse price movements cause the account to
go
below the maintenance.
[0014] The accounts of individual members, clearing firms and non-member
customers doing business through CME must be carried and guaranteed to the
Clearing
House by a clearing member. As mentioned above, in every matched transaction
executed through the Exchange's facilities, the Clearing House is substituted
as the buyer
to the seller and the seller to the buyer, with a clearing member assuming the
opposite
side of each transaction. The Clearing House is an operating division of the
Exchange,
and all rights, obligations and/or liabilities of the Clearing House are
rights, obligations
and/or liabilities of CME. Clearing members assume full fmancial and
performance
responsibility for all transactions executed through them and all positions
they carry. The
Clearing House, dealing exclusively with clearing members, liolds each
clearing member
accountable for every position it carries regardless of whether the position
is being carried
for the account of an individual member, for the account of a non-member
customer, or
for the clearing member's own account. Conversely, as the contra-side to every
position,
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the Clearing House is held accountable to the clearing members for the net
settlement
from all transactions on which it has been substituted as provided in the
Rules.
[0015] The Clearing House does not look to non-member customers for
performance
or attempt to evaluate their creditworthiness or market qualifications. The
Clearing
House does monitor clearing members for the adequacy of credit monitoring and
risk
management of their customers. In addition, although the Exchange has
established
character and financial standards for its individual members, the Clearing
House looks
solely to the clearing member carrying and guaranteeing the account to secure
all
payments and perfom-iance bond obligations. Further, when an individual member
executes orders for a clearing member, his or her guarantor clearing member is
held
accountable as principal for the brokered transaction until the transaction
has been
matched and recorded by the Clearing House as a transaction of the clearing
member for
whom the individual inember had acted.
[0016] The risk management and financial surveillance techniques employed by
CME
are designed to:
= Prevent the accumulation of losses;
= Eilsure that sufficient resources are available to cover future obligations;
= Result in the prompt detection of financial and operational weaknesses;
= Allow swift and appropriate action to be taken to rectify any financial
problems and protect the clearing system.
These techniques are consistent with risk management recommendations by
authoritative
organizations.
[0017] CME derives its financial stability in large part by removing debt
obligations
among market participants as they occur. This is accomplished by determining a
settlement price at the close of the market each day for each contract and
marlcing all
open positions to that price, referred to as "mark to market." Every contract
is debited or
credited, based on that trading session's gains or losses. As prices move for
or against a
position, funds flow into and out of the trading account. Debt obligations
from option
contracts are also immediately removed, since the purchaser of an option must
pay the
premium (cost of the option) in full at the time of purchase. Sellers of
options post
performance bonds, discussed above, as determined by the CME according to the
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prevailing risk characteristics of the options sold. In the case of the CME,
each business
day by 6:40 a.m. Chicago time, based on the mark-to-the-market of all open
positions to
the previous trading day's settlement price, the Clearing House pays to or
collects cash
from each clearing member. This cash flow, known as settlement variation, is
performed
by CME's settlement banks based on instructions issued by the Clearing House.
All
payments to and collections from clearing members are made in "same-day"
funds. In
addition to the 6:40 a.m. settlement, a daily intra-day mark-to-the market of
all open
positions, including trades executed during the overnight GLOBEXO, the CME's
electronic trading systems, trading session and the current day's trades
matched before
11:15 a.m., is performed using current prices. The resulting cash payments are
made
intra-day for same day value. Iu times of extreme price volatility, the
Clearing House has
the authority to perform additional intra-day mark-to-the-market calculations
on open
positions and to call for immediate paynient of settlement variation.
Settlement variation
payments through the Clearing House average $1.4 billion per day and have
reached a
peak of $6.4 billion. CME's mark-to-the-market settlement system stands in
direct
contrast to the settlement systems implemented by many other financial
markets,
including the interbank, Treasury securities, over-the-counter foreign
exchange and debt,
options, and equities markets, where participants regularly assume credit
exposure to each
other. In those markets, the failure of one participant can have a ripple
effect on the
solvency of the other participants. Conversely, CME's mark-to-the-market
system does
not allow losses to accumulate over time or allow a market participant the
opportunity to
defer losses associated with market positions.
[0018] If a clearing member does not have sufficient performance bond
collateral on
deposit with the Clearing House, then the clearing member must meet a call for
cash
performance bond deposits by 6:40 a.m. and/or by 2:00 p.m. Chicago time, which
results
in a direct debit to the clearing member's account at one of CME's settlement
banks.
Clearing members' performance bond deposits may only be:
= Cash (such as U.S. dollars, Japanese yen, Euro currency, Swiss francs,
British pounds, Canadian dollars, Australian dollars, Norwegian krone, and
Swedish krona);
= U.S. Treasury securities;
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= Letters of credit issued in the Exchange's name by approved banks;
= Stocks selected from among approximately half of those in the Standard &
Poor's 500 Stock Price Index and depository trust shares based on the
Standard & Poor's 500 Stock Price Index;
= Selected sovereign debt of Canada, France, Germany, and the UK;
= Discount notes issued by the Federal Farm Credit Banks, Federal Home
Loan Mortgage Corporation, Federal Home Loan Bank System, or Fannie
Mae, provided that the notes have less than six months remaining to
maturity;
= Fixed rate note and bond securities issued by the Federal Farm Credit
Bank, Federal Hoine Loan Bank, Federal Home Loan Mortgage
Corporation, Fannie Mae or Ginnie Mae;
= Interest Earning Facility (IEF 0), a CME managed fund program;
= IEF2: Money Market Mutual Funds allowable under CFTC Regulation
1.25; and
= IEF3 and IEF4: Clearing firm self-directed collateral management program,
which allows collateral instruments allowable permitted under CFTC
Regulation 1.25.
[0019] Securities are revalued every day and are subject to prudent haircuts.
Additionally, foreign cash is subject to haircuts in selected circumstances.
Various forms
of collateral are also subject to limits.
[0020] CME's Clearing House also maintains a Concentration Margining Program,
which allows the Clearing House to charge additional performance bond
requirements
when clearing firms' potential market exposures become large relative to the
financial
resources available to support those exposures.
[0021] In recognition of the growing linkages among the markets for exchange-
traded
equity derivative products, as well as the need to promote efficient clearing
procedures
and to focus on the true intermarket risk exposure of clearing members, CME,
in
conjunction with the Options Clearing Corporation (OCC) and the New York
Clearing
Corporation (NYCC), has developed a cross-margining system with respect to
market
professionals and proprietary accounts. By combining the positions of joint or
affiliated
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clearing members in certain broad-based equity index futures and options into
a single
portfolio, and utilizing the sophisticated risk-based systems of each clearing
organization,
a single performance bond requirement across both markets is determined. The
clearing
organizations jointly hold a first lien on and security interest in the
positions in cross-
margined accounts. All performance bond deposits associated with these
accounts are
jointly held. The cross-margining system significantly enhances both the
efficiency and
financial integrity of the clearing system by treating all positions as being
held in the
same account, which allows gains accruing to futures or options positions to
be
immediately available to meet the requirements for funds from losing
positions. In the
event that a clearing organization suspends a cross-margining member, the
positions in
the cross-margin accounts would be liquidated and all performance bond
collateral would
be converted to cash and applied toward each clearing organization's costs of
liquidating
the cross-margin accounts. CME, the OCC and the NYCC are each entitled to
proportional shares of any surplus to apply toward other obligations of the
clearing
member; if one clearing organization did not need its entire share of the
surplus, the
excess would be made available to the other clearing organizations.
[0022] CME also maintains cross-margin agreements with the London Clearing
House and Fixed Income Clearing Corporation. These programs involve the cross-
margining of selected interest rate products. The design of these two cross-
margin
programs differ from the above mentioned OCC/NYCC program in that performance
bond collateral is held separately at each respective clearing organization.
In the event
that a clearing organization suspends a CME/LCH cross-margining participant,
the cross-
margined positions would be liquidated and performance bond collateral would
be
converted to cash at each respective clearing organization. If as a result of
the liquidation
of cross-margined positions and performance bond there is a resulting cross-
margin loss,
there will be a cross-margin guarantee payment from one clearing organization
to the
other to share the loss. A similarly structured cross-margin program is in
place between
CME and NYMEX for NYMEX energy products versus CME's commodity index
complex.
[0023] The Clearing House Division monitors intra-day price movements
throughout
the trading session. To assess the impact of these price changes on clearing
members, an
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intra-day mark-to-the-market calculation is performed on clearing member
futures and
options positions and reviewed by the Clearing House and Risk Management
Departments several times each day, inore frequently if price volatility is
high. Large or
concentrated positions on the losing side of the market receive special
attention. The
Audit Department may either contact or visit a clearing firm to determine
whether proper
performance bonds have been collected for these positions and to determine
their impact
on the clearing member's capital position and liquidity.
[0024] CME also conducts stress testing of clearing member positions on a
daily
basis. Numerous stress scenarios have been modeled to reflect a diverse
universe of
possible market events. Stress results are evaluated against performance bond
on deposit
and also with clearing member adjusted net capital. Results of stress tests
may lead the
Clearing House to request that the clearing member provide additional
information about
its customer accounts such as whether there are non-CME offsetting positions
in other
markets. In some cases stress test results may cause the Clearing House to
increase a
clearing member's performance bond requirement, or reduce or transfer
positions.
[0025] Through the Division of Market Regulation at CME and working in
conjunction with CBOT's Office of Investigations and Audits (OIA), CME's Risk
Management Team has daily access to specific account position information
regarding
individual members, noiuneinber customers and clearing members, all of which
is
maintained on a highly confidential basis. Such critical information allows
the
identification of concentrated positions as they arise and the aggregation of
positions that
may be owned by common principals through several different clearing members.
Kn.owledge of concentrated or high-risk positions, coupled with information
routinely
gathered on the cash and/or related derivative markets, enables CME to respond
rapidly to
market situations that might adversely affect the clearing system and/or the
ffinancial
stability of a clearing member.
[0026] The Exchanges periodically visit their clearing member firms to review
their
financial, operational and risk management procedures and capabilities. Senior
Clearing
House staff evaluate how well each firm's procedures and capabilities
correspond to its
line of business. Senior staff from Audit, Clearing House, Risk Management,
and Market
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Regulation follow up with the clearing member's senior management if there are
deficiencies found in their risk management procedures and capabilities.
[0027] Risk management and financial surveillance are the two primary
fiinctions of
CME's financial safeguard system. The system is designed to provide the
highest level of
safety and the early detection of unsound financial practices on the part of
any clearing
member. Its purpose is to protect all clearing members and their customers
from the
consequences of a default by a participant in the clearing process. The system
is
constantly being updated to reflect the inost advanced risk management and
financial
surveillance techniques.
[0028] In order to minimize risk to the Exchange while minimizing the burden
on
members, it is desirable to approximate the requisite performance bond or
margin
requirement as closely as possible to the actual positions of the account at
any given time.
Accordingly, there is a need to improve the accuracy and flexibility of the
mechanisms
which estimate performance bond requirements.
BRIEF DESCRIPTION OF THE DRAWINGS
[0029] Figure 1 depicts an exemplary risk management system according to one
embodiment.
[0030] Figure 2 depicts a block diagram of a risk management engine for use
with the
system of Figure 1.
[0031] Figure 3 depicts flow chart showing exemplary operation of the risk
management system of Figure 1, according to one embodiment.
[0032] Figures 4A-4B depict exemplary performance bond requirements.
DETAILED DESCRIPTION OF THE DRAWINGS AND PRESENTLY
PREFERRED EMBODIMENTS
[0033] CME establishes minimum initial and maintenance performance bond levels
for all products traded through its facilities. CME bases these requirements
on historical
price volatilities, current and anticipated market conditions, and other
relevant
information. Performance bond levels vary by product and are adjusted to
reflect changes
in price volatility and other factors. Both initial and maintenance
performance bonds are
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good faith deposits to guarantee performance on futures and options contracts.
Maintenance performance bond levels represent the minimum amount of protection
against potential losses at which the Exchange will allow a clearing member to
carry a
position or portfolio. Should performance bonds on deposit at the customer
level fall
below the maintenance level, Exchange rules require that the account be re-
nlargined at
the required higher initial performance bond level. Clearing members may
impose more
stringent performance bond requirements than the minimums set by the
Exchanges. At
the Clearing House level, clearing members must post at least the maintenance
performance bonds for all positions carried. This requirement applies to
positions of
individual members, nonmember customers and the clearing member itself.
[00341 In setting performance bond levels, the Clearing House monitors current
and
historical price movements covering short-, intermediate- and longer-term data
using
statistical and parametric and non-parametric analysis. The Clearing House and
CME
Board of Directors then typically set futures maintenance performance bond
levels to
cover at least the maximum one-day price move on 95% of the days during these
time
periods. The actual performance bond requirements often exceed this level.
Performance
bond requirements for options reflect movements in the underlying futures
price,
volatility, time to expiration and other risk factors, and adjust
automatically each day to
reflect the unique and changing risk characteristics of each option series. In
addition,
long options must be paid for in full, and CME mandates stringent minimuin
performance
bonds for short option positions. Exemplar performance bond requirements are
shown in
Figures 4A-4B.
[0035] CME calculates performance bonds using a system developed and
implemented by CME called Standard Portfolio Analysis of RiskTM (SPAN ). SPAN
bases perfonnance bond requirements on the overall risk of the portfolios
using
parameters as determined by CME's Board of Directors, and thus represents a
significant
improvement over other performance bond systems, most notably those that are
"strategy-
based" or "delta-based." Delta is the measure of the price-change relationship
between an
option and the underlying futures price and is equal to the change in premium
divided by
the change in futures price. SPAN simulates the effects of changing market
conditions
and uses standard options pricing models to determine a portfolio's overall
risk. It treats
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futures and options uniformly while recognizing the unique features of
options. In
standard options pricing models, three factors most strongly affect options
values: the
underlying futures price, volatility (variability of futures price) and time
to expiration. As
these factors change, futures and options may gain or lose value. SPAN
constructs
scenarios of futures prices and volatility changes to simulate what the entire
portfolio
might reasonably lose over a one day time horizon. The resulting SPAN
performance
bond requirement covers this potential loss.
[0036] SPAN evaluates overall portfolio risk by calculating the worst probable
loss
that a portfolio might reasonably incur over a specified time period. SPAN
achieves this
number by comparing hypothetical gains and losses that a portfolio would
sustain under
different market conditions. SPAN typically provides a'Risk Array" analysis of
16
possible scenarios for a specific portfolio under various conditions. SPAN
methodology,
however, allows users to request any number of scenarios to meet their
particular needs:
- Each scenario consists of a "what-if 'situation in which SPAN assesses
the effects of variations in price, volatility and time to expiration; and
- Each calculation represents a gain or loss based on the possible gains or
losses due to changes in an instrument's price by X and volatility by Y.
[0037] SPAN licensed clearing organizations and exchanges determine for
themselves
the following SPAN parameters, in order to reflect the risk coverage desired
in any
particular market:
- Price Scan Range: A set range of potential price changes;
- Volatility Scan Range: A set range of potential implied volatility changes;
- Intra commodity Spread Charge: An amount that accounts for risk (basis
risk) of calendar spreads or different expirations of the same product,
which are not perfectly correlated;
- Short Option Minimum: Minimum margin requirement for short option
positions;
- Spot Charge: A charge that covers the increased risk of positions in
deliverable instruments near expiration; and
- Intercommodity Spread Credit: Margin credit for offsetting positions
between correlated products.
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[0038] SPAN combines financial instniments within the same underlying for
analysis,
and refers to this grouping as the Combined Commodity group. For example,
futures,
options on futures and options on equities on the same stock could all be
grouped under a
single Combined Commodity.
[0039] To calculate a performance bond requirement, for each Combined
Commodity
in a portfolio, SPAN will:
- Sum the Scan Risk charges, any Intracommodity Spread and Spot Charges;
- Apply the offsets for all Intercommodity Spread Credits within the
portfolio;
- Compare the above sum with any existing Short Option Minimum
requirement; and
- Assess the greater of the two compared as the risk of the Combined
Commodity.
[0040] The Total Margin Requirement for a portfolio is the sum of the risk of
all
Combined Commodities less all credit for risk offsets between the different
Combined
Commodities.
[0041] Here's an example of a portfolio with CME Euro FX Futures and Options
positions:
- Euro FX Futures:l Long June 04
- Euro FX Options on Futures: 1 Short June/JuneO4 Call 1.150 Strike
- Euro FX June Futures Settlements 1.1960
- Euro FX Futures Price Scan Range =$2400 = 192 points
- Euro FX Volatility Scan Range = 1%
# One Long One Short Portfolio Scenario
June 04 Euro June on June Description
FX 04 1.150 Call
Euro FX
Option
1 $0 -$130 -$130 Price
unchanged;
Volatility up
the Scan Range.
2 $0 $155 $155 Price
unchanged;
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Volatility down
the Scan Range
3 $800 -$785 $15 Price up 1/3 the
Price Scan
Range;
Volatility vp
the Scan Range
4 $800 -$531 $268 Price up 113 the
Price Scan
Range;
Volatility down
the Scan Range
.$800 $500 $300 Price down 113
the Price Scan
Range;
Volatility up
the Scan Range
6 -$800 $815 $15 Price down the
1/3the Price
Scan Range;
Volatility down
the Scan Range
7 $1600 -$1463 $137 Price up 2/3 the
Price Scan
Range;
Volatility up
the Scan Range
8 $1600 -$1240 $360 Price up 2/3 the
Price Scan
Range;
Volatility down
the Scan Range
9 -$1600 $1102 -$498 Price down
2/3the Price
Scan Range;
Volatility up
the Scan Range
-$1600 $1446 -$154 Price down
2/3the Price
Scan Range;
Volatility down
the Scan Range
11 $2400 -$2160 $240 Price up 3/3 the
Price Scan
Range;
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Volatility down
the Scan Range
12 $2400 $1967 $433 Price down 3/3
the Price Scan
Range;
Volatility down
the Scan Range
13 -$2400 $1674 -$726 Price down the
Price Scan
Range;
Vola6lity up the
e
Scan Rang
14 -$2400 $2043 -$357 Price down 3/3
the Price Scan
Range;
Volatility down
the Scan Range
15 $2304 -$2112 $192 Price up
extreme (3
times the Price
Scan Range) -
Cover 32% of
loon
16 -$2304 $1466 -$838 Price down
extreme (3
times the Price
Scan Range)-
Cover 32% of
loss
[0042] In the sample portfolio above, in scenario 8, the gain on one long June
04 EC
futures position offsets the loss of one short EC June/June 04 1.150 call
option position,
incurring a gain of $360. In scenario 16, the portfolio would incur a loss of
$838 over the
next trading day, which is 32% of the resulting loss if the price of the
underlying future
decreases by three times the price scan range. After SPAN has scanned the
different
scenarios of underlying market price and volatility changes, it selects the
largest loss
among these observations. This "largest reasonable loss" is the Scan Risk
charge. In this
example, the largest loss across all 16 scenarios is a result of Scenario 16,
a loss of $838.
[0043] A number of common features are integrated into the SPAN software
family.
All SPAN software products:
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- Are Windows-based and have the familiar look and feel of today's most
widely used desktop software products;
- Feature free access to daily SPAN arrays from a variety of exchanges and
clearing organizations around the world;
- Feature extensive, detailed and well-documented reports on Portfolio and
Risk parameters;
- Include an XML-based reporting module which provides for simple data
import and export to Access or Excel;
- Are supported by the CME Clearing House's Risk Management experts
via a dedicated SPAN hot/me and email address;
- Run in batch or GUI interactive mode and can be automated with simple
scripting language; and
- Support multiple currencies and the widest possible variety of instruments
including stocks, bonds, OTC derivatives, cash, futures, and options.
[0044] PC-SPAN is single-user desktop software that enables a user to enter
positions
manually or by using scripting language to automate the position entry
process. With a
click of the mouse, the SPAN requirement is known. As thousands of users can
attest,
PC-SPAN allows for an extremely quick, inexpensive and simple way to calculate
margin
requirements across multiple exchanges.
[0045] The Span Risk Manager is a single-user, desktop software that
integrates risk
management features with the latest processing technology to deliver an
extremely
flexible, intuitive system for full portfolio risk management. Span Risk
Manager's
powerful features and intuitive design allow for true portfolio analytics
through multi-
variant stress testing and option exposures.
[0046] Specifically, SPAN Risk Manager:
- Enables users to gauge the effects, on a total portfolio or an individual
option, of:
+ Changes in price
+ Implied volatility
+ Time to expiration
+ Dividend yields
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+ Interest rates
- Calculates hypothetical P&L's, option prices, and Greeks
- Calculates implied, average call/put and series volatilities
- Allows for stress testing of multiple products
- Allows user to define, compare, save and reload "What-If' Scenarios for
stress testing
- Enables the user to shift volatility skews
- Provides simultaneous analyses on several different trading instruments
- Supports the following option pricing models:
+ Black-Scholes
+ Merton
+ Adesi-Whaley
+ Cox-Ross-Rubenstein
[0047] At the top of the SPAN software hierarchy is SPAN Risk Manager
Clearing.
This program employs all of the fiulctionalities of PC-SPAN and SPAN Risk
Manager
plus several additional features which are applicable to entities such as
exchanges,
clearing organizations, and service bureaus. These features include:
- "What-If' Margining - Allows an organization to view and compare
hypothetical margins under multi-variant "What-if' scenarios;
- Real-Time Component Interface -Allows for real-time SPAN margining
and pro or post execution credit controls;
- Automated Production and Publication of SPAN Risk Array files - Takes
the work out of creating a publishing a daily SPAN Risk Array file to the
world; and
- Complex Implied Volatility Averaging.
[0048] As described above, SPAN is utilized by both the Exchange and is also
provided as a tool which may be used by clearing members or other entities to
determine
their anticipated performance bond requirements. In this way, clearing
members, or other
entities, may anticipate the performance bond requirements of the clearing
house which
facilitates financial planning and certainty. SPAN is also made available as a
product to
be used by clearing houses of other exchanges. It will be appreciated that the
disclosed
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embodiments are equally applicable to both the version of SPAN used by the
exchange
and the version used by the market participants and that any discussion herein
referring to
SPAN is intended to be applicable to both applications.
[00491 Another system for assessing risk in a portfolio is the Theoretical
Intermarket
Margin System ("TIMS") manufactured by The Options Clearing Corporation,
located in
Chicago, Illinois. TIMS allows clearing institutions to measure, monitor and
manage the
level of risk exposure of their members' portfolios. TIMS can calculate risk
exposure at
different account levels and for different account types. In addition, TIMS
uses portfolio
theory to margin all positions relating to the same underlying product and
combines the
risk of closely related products into integrated portfolios. This portfolio
aspect of TIMS
allows for the recognition of hedges used by market participants in
increasingly
interrelated markets. The TIMS methodology allows for measuring the monetary
risk
inherent in portfolios containing options, futures and options on futures
positions.
[0050] In particular, TIMS uses pricing models to project the liquidation
value of each
portfolio given changes in the price of each underlying product. These models
generate a
set of theoretical values based on various factors including current prices,
historical prices
and market volatility. Based on flexible criteria established by a
clearinghouse,
statistically significant hedges receive appropriate margin offsets. TIMS also
is used to
predict a member's potential intra-day risk under varying sets of assumptions
regarding
market behavior.
[0051] TIMS organizes all classes of options and futures relating to the same
underlying asset into class groups and all class groups whose underlying
assets exhibit
close price correlation into product groups. The daily margin requirement for
a clearing
member is calculated based on its entire position within a class group and
various product
groups. The margin requirement consists of two components, a mark to marlcet
component and an additional margin component.
[0052] The mark to market component takes the form of a premium margin
calculation that provides margin debits or requirements for net short
positions and margin
credits for net long positions. The margin debits and credits are netted to
determine the
total premium margin requirement or credit for each class group. The premium
margin
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component represents the cost to liquidate the portfolio at current prices by
selling the net
long positions and buying back the net short positions.
[0053] The additional margin component, the portion of the margin requirement
that
covers market risk, is calculated using price theory in conjunction with class
group
margin intervals. TIMS projects the theoretical cost of liquidating a
portfolio of positions
in the event of an assumed worst case change in the price of the underlying
asset.
Theoretical values are used to determine what a position will be worth when
the
underlying asset value changes. Given a set of input parameters (i.e., option
contract
specifics, interest rates, dividends and volatility), the pricing model will
predict what the
position should theoretically be worth at a specified price for the underlying
instrument.
[0054) The class group margin interval determines the maximum one day increase
in
the value of the underlying asset (upside) and the maximum one day decrease in
the value
of the tulderlying asset (downside) that can be expected as a result of
historical volatility.
The metlzodology used to determine class group margin intervals and product
groups can
be specified by each clearing institution. OCC's methodology for determining
class group
margin intervals is based on ongoing statistical analysis. For each class
group, the
standard deviation is coinputed and a margin interval is calculated which
covers a
predetermined percentage specified by the clearinghouse. This approach
provides both a
confidence level and historical perspective on volatility and accounts for any
non-normal
price distribution patterns. TIMS also calculates theoretical values at equal
intervals
between the two endpoints (upside and downside) and at the current market
value to
protect against certain trading strategies that may have their largest loss
between these
two endpoints.
[00551 The methodology for detennining which class groups comprise a product
group and the appropriate percentage deduction to account for the lack of
perfect
correlation between class groups is also based on ongoing statistical
analysis. For each
pair of class groups, TIMS computes a coefficient of determination. TIMS
assigns class
groups to a product group when the value of the coefficient between the class
groups is
within policy limits established by the clearinghouse. The product group
percentage or
offset is established based on the lowest coefficient of determination among
all of the
class groups included in the product group. When calculating an account's
total margin
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requirement, this specified percentage of any margin credits at the class
group level is
used to offset margin requirements generated by other class groups in the same
product
group.
[0056] Yet another risk management system is the OMS II system, also referred
to as
the "Window method" or the "Vector method". OMS II is the OM risk calculation
method for calculating margin requirements. It is included in the risk
valuation or RIVA
system within OM SECUR. It was constructed in order to handle non-linear
instruments
in a better way than SPAN or TIMS. OMS II calculates worst case loss
scenarios, store
these in vectors, adjust for spreading, and adds the vectors in a way that
takes correlation
in to account.
[0057] In OMS II the valuation interval is divided into n(normally n=31)
possible up
or down moves, additionally for each up or down move the volatility can either
increase
stand still or decrease. This gives us 93 alternative market scenarios (if
n=31) to calculate
the profit or loss a portfolio will make.
[0058] The scenario with no price move at all is the middle scenario and
around it
there are 15 up and 15 down scenarios (or (n-1)/2 up and (n-1)/2 down
scenarios).
TABLE: OMS valuation scenarios. (n=31)
Underlying Price Volatility
Scan Range Scan Range
1 Price unchanged Volatility down
2 Price unchanged Volatility unchanged
3 Price unchanged Volatility up
4 Price up 1/15 range Volatility down
5 Price up 1/15 range Volatility unchanged
6 Price up 1/15 range Volatility up
7 Price down 1/15 range Volatility down
8 Price down 1/15 range Volatility unchanged
9 Price down 1/15 range Volatility up
10 Price up 2/15 range Volatility down
11 Price up 2/15 range Volatility unchanged
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12 Price up 2/15 range Volatility up
13 Price down 2/15 range Volatility down
14 Price down 2/15 range Volatility unchanged
15 Price down 2/15 range Volatility up
88 Price up 15/15 range Volatility down
89 Price up 15/15 range Volatility unchanged
90 Price up 15/15 range Volatility up
91 Price down 15/15 range Volatility down
92 Price down 15/15 range Volatility unchanged
93 Price down 15/15 range Volatility up
[0059] As in both SPAN and TIMS, one can view OMS II mathematically as
producing the maximum of the expected loss under each of 93 probability
measures. For
al193 scenarios the probability measures are point masses at each of the 93
points in a
space 0 of securities prices and volatilities.
[0060] Each valuation point is saved in a 31x3 matrix, that is, each row
contains a
price move and the three volatility fluctuations. The matrix is expanded to a
31x6 matrix
so that the case of both a bought and a sold contract is represented in the
matrix, this
because of additional fine-tunings that are available in OMS II. The matrixes
are saved
for use when margin requirements of portfolios are calculated.
[0061] In the case of an account containing positions of two or more types of
contracts
the risk of the position is the combined risk characteristics of the different
contracts
registered to the account. To take the offsetting characteristics of the
instrument into
account one talks about cross margining. The default cross margining divides
the
positions into one group per underlying. Positions on instruments within the
same
underlying are said to be totally correlated. The default cross margin can be
described as
instruments with the same underlying being totally correlated and instruments
with
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different underlying being uncorrelated. During a default cross-margin run a
portfolio
with instruments on the same underlying will add the valuation files pointwise
as in
SPAN and then take the largest negative value as the margin requirement for
the
portfolio6. If the portfolio consists of instruments on different underlyings
the largest
negative value of each valuation file will be added.
[0062] However, a method such as default cross margining does not take
correlations
between different underlyings or different expiry months into consideration.
Therefore in
OMS II one uses the so-called "Window method" when a portfolio containing
instnments on different underlyings or contracts with different expiry months
is
margined.
[0063] In the window method, the different instruments are sorted into a
number of
groups, called window classes. The window classes have a window size defined
in
percent. When the percentage goes down the correlation goes up and vice versa,
e.g. a
window size of 0% means that the instruments in the window class are totally
correlated
and a window size of 100% means that the instruments in the window class are
uncorrelated. There is also a possibility for a window class to be a member of
another
window class, and in such case creating a tree structure of more complicated
correlations.
To calculate the margin for a portfolio, the window is moved from left to the
right over
the entire valuation interval for all window classes, starting with the ones
in the bottom of
the tree. The window is centered over each valuation point. A margin
requirement is
calculated at each valuation point where the window is positioned by adding
the lowest
value for each option position or futures position shown in the window. The
total margin
requirement will be the largest negative value of all these margin
requirements. If there is
no negative value this indicates a credit and no margin is required.
[0064] The risk calculation part of OMS, without use of any fine-tunings,
should also
be a coherent risk measure, this since the calculations only differ in the
amount of
scenarios used. OMS uses far more scenarios then both SPAN and TIMS.
[0065] A comparison of SPAN, TIMS and OMS II may be found in Bylund, Mattias,
"A Comparison of Margin Calculation Methods for Exchange Traded Contracts"
(February 21, 2002). Royal Institute of Technology Dept. of Mathematical
Statistics,
Master Thesis No. 2002-3. hri~p://ssrn.com/abstract=300499, herein
incorporated by
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reference. While the disclosed embodiments will be discussed with reference to
the
SPAN risk analysis software, it will be appreciated that they may also be
applicable to
the TIMS risk analysis software, as well as other products directed at
determining
performance bond requirements and/or assessing risk in a portfolio of
derivatives.
[00661 The CME Clearing House requires "gross" performance bonds for customer
positions in CME products. The clearing member must deposit performance bonds
for
each open position (long or short) held at the end of each day's trading, with
appropriate
allowances for spreads. A spread is the price difference between two
contracts, e.g.,
holding a long and a short position in two related fu.tures or options on
futures contract,
with the objective of profiting from a changing price relationship or the
assumption of a
long and short position on the same business day in the same or related
commodities for
the same account. Long refers to one who has bought a futures or options on
futures
contract to establish a market position and who has not yet closed out this
position
through an offsetting procedure, e.g. one who has bought a futures or options
contract to
establish a market position; a market position which obligates the holder to
take delivery;
or one who owns an inventory of commodities. Long is the opposite of short.
[0067] A Spread order - Open Outcry: is an order that indicates the purchase
and sale
of futures contracts simultaneously. A Spread trade is the simultaneous
purchase and sale
of futures contracts for the same commodity or instrument for delivery in
different
months or in different but related markets. A spreader is not concerned with
the direction
in which the market moves, but only with the difference between the prices of
each
contract.
10068] Spreads include Bear spreads, Bull Spreads, Butterfly spreads, Calendar
spreads and user defined spreads. A Bear spread is a vertical spread involving
the sale of
the lower strike call and the purchase of the higher strike call, called a
bear call spread.
Also, a vertical spread involving the sale of the lower strike put and the
purchase of the
higher strike put, called a bear put spread. A Bull spread is a vertical
spread involving the
purchase of the lower strike call and the sale of the higlier strike call,
called a bull call
spread. Also, a vertical spread involving the purchase of the lower strike put
and the sale
of the higher strike put, called a bull put spread. Butterfly spreads can be
fatures or
options spreads. As an option spread, a Butterfly spread is a strategy
combining a bull
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and bear spread and uses three strike prices. The strike price is the price at
which the
option buyer may purchase or sell the underlying futures contract upon
exercise. The
lower two strike prices are used in the bull spread and the higher strike
price from the
bear spread. Both puts and calls can be used. A Calendar spread, also known as
a futures
calendar spread or futures intra-delivery spread, is the simultaneous purchase
and sale of
the same futures contract, but for different contract months, for example,
buying a
September S&P 500A futures contract and selling a December S&P 500 futures
contract. An options calendar spread is the simultaneous purchase and sale of
options of
the same strike, but different expiration dates. User defined spreads relate
to the ability to
choose the legs of a spread if the spread is not identified by Exchange
already.
[0069] In general, the purchase or sale of a futures contract is considered to
be an
outright long or short position. However, another strategy known as spread
trading is also
available to the hedger and speculator. Spread trading involves the
simultaneous
purchase of one commodity contract against the sale of another related
contract. Natural
spread opportunities are available in the energy market between different
months of the
same commodity contract, as well as between different products and grades.
Some
players confine themselves to trading outright futures and options contracts,
leaving the
enormous potential of the spread markets untapped. This is primarily due to
the
misconception that spreads are inherently more complex than outright
positions. While
there can be additional risk holding both long and short positions in
different commodity
contracts, it is generally accepted that having a position off-set by an equal
but opposite
position in anotlier commodity contract should lessen one's risk. This is
reflected by the
fact that spread positions are less costly to margin than outright positions.
The hedger can
benefit from the spread market as well. If spread values are closely
monitored, they can
provide valuable information as to when and where a hedge should be placed.
[0070] There are four basic types of spreads. Though the most commonly traded
is
the intramarket spread, they are all consistently played in the oil market.
1. Intramarlcet Spreads: This spread consists of a long position in one
contract
month against a short position in another contract month in the same
commodity. For example: Buy April Crude Oil - Sell May Crude Oil on
the NYMEX.
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2. Intermarket Spread: These spreads feature similar or related commodities
on different exchanges. For example: Buy April IPE Gas oil -- Sell April
NYMEX Heating oil or Buy April IPE Brent -- Sell April NYMEX Crude
oil. Strictly interpreted, this defniition is confusing when applied to the
oil
market, because spreads between different commodities on the same
exchange are sometimes thought of as intermarket spreads.
3. Intercommodity Spreads: These spreads are comprised of a long position in
one commodity, and a short position in a different but economically related
commodity. For example: Buy April Gasoline -- Sell April Heating oil.
4. Commodity-Product Spreads: This can be defmed as the purchase of a
commodity against the sale of an equivalent amount of the product derived
from it (or vice versa). In the oil market, this is referred to as a "crack
spread." For example: Buy 3 September Crude oil -- Sell 2 September
Gasoline + Sell 1 September Heating oil.
[0071] In theory, spread transaction is established in expectation that the
differential
between contacts will widen or narrow. Each side of the spread is referred to
as a "leg."
If the trader buys the higher, more valuable leg of the spread, he anticipates
that the
differential will widen. Conversely, if he sells the higher leg, he believes
it will narrow.
Whether the trader is long or short the spread depends upon what he has done
to the more
valuable (premium) leg. This holds true regardless of whether the market is at
a carry or
a discount.
[0072] For example: Assume November Crude oil is trading at $14.00, and
December
Crude oil is at $14.25. The trader buys the premium leg - December, in belief
that the .25
cent spread will widen (while simultaneously selling the November).
[0073] As the market gains in strength, November moves to $14.75, and December
to
$15.50. To calculate the profit or loss, simply examine the profit or loss on
each leg, and
then the net result. In this example, the trader has lost 75 cents on the
short leg- but has
made $1.25 on the long leg. The result is a 50 cent net profit. Stated another
way, the
spread has widened from 25 cents to a 75 cent differential. It is important to
note that the
movement of the spread value is dependent upon the movement of the individual
legs.
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[0074] Spreading in Practice - Spread orders are normally placed by specifying
the
amount of difference between the two contracts of the spread, not the price
level of each
contract. Without this latitude spread orders would be impossible to fill
because of the
unlikelihood that both contracts would be at those exact prices at the saine
moment. The
two most common types of spread orders are "market" and "limit." The market
order
would be the logical choice when spread values are unwavering and prompt
execution is
desired. If spread values are volatile, specific limits on the differential
should be stated.
The simplest type of spread order to execute is the one between two months of
the same
commodity. In this case, values are easy to determine because they are quoted
in the
same trading pit, much like an outright contract. Spreads between different
commodities
or exchanges are usually more difficult to execute. It should be noted that it
is rarely
advisable to place or liquidate spreads one side at a time. This practice of
"legging"
spreads can quickly turn a profitable trade into a loser. One should also
avoid playing
spreads involving the nearest expiring contract unless there is substantial
liquidity
remaining. A lack of liquidity can increase the potential for loss, as it may
mitigate or
exaggerate spread differentials. To determine the liquidity of a contract,
simply compare
the open interest to that of the otlier contracts.
[0075] Basic Spread Strategies - A trader uses the same skills to determine
the
potential of a spread as he would an outright position. Both technical and
fundamental
factors may influence his decision to buy or sell a spread. Consequently, the
technical
relationship between potential contracts are weighed along with the effects of
supply and
demand. There is no general rule that says that a spread will offer greater
profit potential
than an outright position, nor will it always be less risky. However, careful
development
of spread techniques can often translate into large profits.
[0076] Carrying Charge Strategies - Since oil is a non-perishable conunodity,
the
maximum premium that the distant months may sell over the nearby month for a
prolonged period is limited to the cost of carry. If full carrying costs are
evident, very
little risk, other than that created by changes in interest rates, is involved
if your company
sells the spread (long the nearby - short the differed, in an ascending
market). Widening
of the spread, which would create losses, is limited, while there is no limit
to the amount
that the nearby can run over the backs. In a carrying charge market, selling
the nearby
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27
month and buying the distant, is usually not desirable. In that instance, the
profit would be
limited to full carrying charges, and the loss could be unlimited.
[0077] Inverted Market Strategies - The fact that the oil markets are often
inverted
(with the nearby month at a premium to the distant months) presents
interesting
challenges to the spread trader. It is still possible to profit if changes in
differentials can
be predicted. In a discount or inverted market, if one expects the discount to
becoine
smaller, the trader must sell the nearer and buy the distant contract. In
order to profit
when the discounts on the far months are expected to increase, one must buy
the front and
sell the back.
[0078] Calculating SPAN requirements -- i.e., the risk performance bond
(margin)
requirements obtained using the Standard Portfolio Analysis of Risk system or
the SPAN
calculation algorithm, utilizing the disclosed embodiments, is described below
in detail.
[0079] The SPAN algorithm has always been viewed as being applicable to an
unlimited range of product types, but the original focus in its implementation
has been on
standardized futures, options on futures and options on physicals. Portfolios
today,
however, can contain the widest range of derivative and non-derivative
instruments.
SPAN 4 supports the ultimate in product flexibility using an advanced, object-
oriented
model. In particular, SPAN 4 adds support for equity securities and debt
securities
(stocks, bonds, etc.), and options thereon.
[0080] Despite these enhancements, the fundamentals of the SPAN calculation,
and
the principles behind them, have not changed. The underlying simplicity of
SPAN has
been preserved. The many new capabilities introduced with SPAN 4 should be
thought
of not as changes to the underlying methodology, but as providing a vastly
greater degree
of flexibility and control in the usage of SPAN.
[0081] Account types: Portfolios of positions to be margined using SPAN are
held in
performance bond accounts, or margin accounts. The positions in an account
constitute a
single portfolio.
[0082] If this is a particular performance bond account of a clearing member
firm at a
clearing organization, we say that the SPAN calculation done by that clearing
organization for that account is a clearing-level calculation.
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[0083] On the other hand, SPAN calculations may be done for particular
customer or
other accounts of firms which are clearing members, directly or indirectly, of
one or more
clearing organizations. These are firm-level, also called customer-level,
calculations.
[0084] For any performance bond account, the account type is defined by:
= whether this is a clearing-level account or a firm-level account, and
= the specific account type code -- for example, member, hedger, or
speculator.
Business functions and exchange complexes
[0085] A business function represents a particular purpose for which an
exchange or
clearing organization using SPAN wishes to perform the SPAN calculation or
have it
performed, at either the clearing-level or the customer-level. For example:
= Normal clearing-level calculation for a particular clearing organization,
applicable
to normal clearing-level account types
= Special member-clearing calculation for member clearing account types
= Normal customer-level calculation for the part of a portfolio traded on, or
cleared
by, a particular exchange or clearing organization
= Clearing-level calculation for a particular cross-margin agreement between
clearing organizations
= Customer-level calculation for a customer portfolio for a particular cross-
margin
agreement
[0086] By definition, a clearing-level SPAN calculation for a portfolio is
always for a
specific business function. In other words, the portfolio is identified with a
specific
business function, and may contain only products eligible for that business
function.
[0087] By contrast, a customer-level portfolio may have any number of business
functions represented within the portfolio.
[0088] Business functions are also referred to in SPAN as exchange complexes,
and
the identifier for a business function as the exchange complex acronym. For
example,
CME represents the exchange complex acronym for normal processing for the CME
clearing organization
[0089] Requirement levels: For any particular business function represented
within a
portfolio, the exchange or clearing organization using SPAN may mandate the
calculation
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of more than one SPAN requirement number. Each such number is called a
requirement
level, and is specific to:
= the performance bond class of the requirement level, and
= the initial or maintenance designation of the requirement level.
[0090] Performance bond classes are used generically to designate different
levels of
SPAN requirements. The first class (the one with the lowest requirement level)
is
specially designated as the core class and the second class (the one with the
next-highest
requirement level) as the reserve class.
[0091] Any number of performance bond classes can be defined, and for any
purpose.
The most common purpose is to recognize different requirement levels that may
be met
by different classes of collateral assets. Typically the core requirement must
be met by
the highest-quality assets. The difference between the core requirement and
the higher
reserve requirement -- the so-called reserve additional requirement -- may be
met by
certain lesser-quality assets.
[0092] Within the specific performance bond class, the exchange or clearing
organization using SPAN may mandate the distinction between the initial
requirement
level and the maintenance requirement level. The initial requirement is
typically higher
and applies to newly created portfolios. The lower maintenance requirement
applies to
previously existing portfolios. Typically this distinction is only made at the
customer-
level, and only for speculative customer portfolios.
[0093] Coinbined cominodities: For each business function for which an
exchange or
clearing organization is using SPAN, the set of products eligible for that
business function
are grouped into combined commodities.
[0094] For each business function within a portfolio for which the SPAN
calculation
is being done, for each combined commodity represented within that business
function,
SPAN yields one or more SPAN risk requirements. Each such requirement
corresponds
to a specific SPAN requirement level -- a specific performance bond class and
an initial
or maintenance designation.
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[0095] SPAN requirements calculated for individual combined commodities
represented in the portfolio are then aggregated to yield SPAN requirements
for the
different business functions represented within the portfolio, and for the
entire portfolio.
[0096] The combined commodity may be thought of as the atomic-level of the
SPAN
calculation. It is the lowest breakdown of the products within a portfolio at
which a
performance bond requirement is obtained.
[0097] Typically, all products on the same ultimate underlying physical are
grouped
together into a combined commodity -- for example, at the CME, all products
related to
the S&P 500 stock index.
[0098] Performance bond currencies: For each combined commodity, a single
currency is specified as the performance bond currency for that combined
commodity.
[0099] This is the currency in which the performance bond requirement for a
combined commodity represented within a portfolio, will be denominated in.
[00100] Any number of performance bond currencies may be represented within
the
portfolio. Therefore, when aggregating SPAN requireinents for the different
combined
commodities represented within the portfolio, these are typically first
aggregated by
performance bond currency.
[00101] These currency-level requirements may then be converted to a common
currency for further aggregation. This common currency is typically called the
native
currency for the portfolio.
[00102] (The term "native currency" is used to reflect the fact that the
desired
common currency may be different for different portfolios, typically depending
on the
national origin of the portfolio owner.)
[00103] SPAN risk parameter files: Clearing organizations and/or exchanges
using
SPAN publish, at least once daily, one or more SPAN risk parameter files. For
simplicity, these are typically referred to as SPAN files.
[00104] SPAN risk parameters may be generically defined as the set of data
needed
to calculate SPAN requirements, other than the actual portfolios for which the
requirements are to be calculated. SPAN risk parameters consist of (a) product
data and
(b) performance bond rate data. In effect, a SPAN risk parameter file contains
SPAN risk
parameter data in machine-readable form.
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[00105] Typically, SPAN rislc parameter files contain data for exactly one
point in
time. In effect, they contain data to be used for performance bond
calculations for
portfolios existing at that point in time.
[00106] Within each point in tiune, the SPAN file contains data for one or
more
business functions of the exchange or clearing organization publishing the
file. Within
each business function, the file will contain data for each combined commodity
defined
for the business function.
[00107] Ultimately, the file will contain many different SPAN rates -- for
example,
risk arrays, intracommodity spread charge rates, intercommodity spread credit
rates, etc.
Each such rate is qualified by the account type and requirement level to which
it pertains.
[00108] For example, a risk array for a particular contract contained with a
typical
customer-level SPAN file may be designated as being for a hedge customer
account, for
the core performance bond class, and the maintenance requirement.
[00109] SPAN file formats previously in use only supported the inclusion of
data
for exactly one point in time, business function, and rate -- i.e., account
type, performance
bond class, and initial or maintenance designation.
[00110] The new XML-based SPAN file format does not have this limitation.
[00111] Point in time: Risk parameters and portfolios are defined at
particular
points in time.
[00112] Points in time are categorized as to whether they are for:
= the end of day settlement, or
= an intraday point in time.
[00113] Some clearing organizations, for some business functions, may publish
more than one SPAN file for the end-of-day settlement. These are typically
distinguished
as being for:
= the final settlement, or
= an early (or preliminary) settlement, or
= the complete settlement.
[00114] In the early settlement SPAN file, typically final end-of-day
settlement
prices are available only for some of the products, while other products have
intraday
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prices provided. The final settlement file typically contains final settlement
prices for the
day for all actively trading contracts. The complete file will contain final
settlement
prices for all contracts, actively trading or inactive.
[00115] An intraday point in time is further characterized by its business
time --
indicating the actual time to which prices and risk arrays pertain. A point in
time,
whether intraday or end of day, may also be characterized by its run number --
for
example, the first intraday run, the second intraday run, etc.
[00116] Risk arrays, risk scenarios, composite deltas, scan points and delta
points
[00117] Risk arrays: A risk array is a set of numbers, defined:
= for a particular contract
= at a particular point in time
= to be margined for a particular business function
= for a particular account type, and
= for a particular requirement level -- performance bond class and initial or
maintenance designation -- for that account type.
[00118] Each risk array value specifies how a single long or short position
will lose
or gain value if the corresponding risk scenario occurs over the specified
look-ahead time.
By convention, losses for long positions are expressed as positive numbers,
and gains as
negative numbers.
[00119] The lookahead time: The lookahead time reflects the amount of time
into
the future from the current time, for which the SPAN requirement levels are
intended to
protect against declines in portfolio value. Lookahead time is a parameter of
SPAN and
may be set to any desired value. There are two methods, however, which are
typically in
use for its specification:
= Actual time to the next business day: in this method, the number of calendar
days
from the current business day to the next business day is determined, and then
divided by 365 days per year, to obtain the lookahead time in years.
= Average time per business day: in this method, the lookahead time is
typically set
to one business day in a business year assumed to have 250 business days per
year,
or 0.004 years.
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[00120] Use of actual time to the next business day more closely protects
against
the risk of larger changes in portfolio value over weekends and holidays, and
may result
in increased portfolio performance bond requirements on the business day prior
to a
weekend, especially a holiday weekend. If, however, it is desired to avoid
having the
performance bond requirement fluctuate merely because of weekends and
holidays, use of
average time per business day is more appropriate.
[00121] Risk Scenarios: Each risk scenario is defined in the following terms:
= the (underlying) price movement
= the (underlying) volatility movement, and
= the weight, also called the covered fraction.
[00122] For futures, physicals and other non-option product types, these are
the
price movement and volatility movement for the instrument itself. For options,
these are
the price and volatility movements for the underlying instrument.
[00123] The values of the price movement, the volatility movement, and the
covered fraction are determined by the scan point definitions and the two scan
ranges --
the price scan range and the volatility scan range. These values are the key
inputs to
SPAN.
[00124] Scan point definitions: Each scan point definition consists of
= the price scan magnitude, as the number of price scan ranges up or down --
for
example, .3333 or -2.000, meaning one third of the price scan range up, or
twice
the price scan range down
= the volatility scan magnitude, as the number of volatility scan ranges up or
down -
- for example, 1.0000 or -1.000, meaning the full volatility scan range up or
down
= the weight.
[00125] The price scan magnitude may itself be expressed in terms of a price
scan
numerator, a price scan denominator, and a price scan direction. For example,
a price
scan magnitude of -.3333 may be expressed as a numerator of one, a denominator
of
three, and a direction of down. Similarly, the volatility scan magnitude may
be expressed
in terms of a volatility scan numerator, a volatility scan denominator, and a
volatility scan
direction.
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[00126] SPAN 4 allows the defuiition, for each combined commodity of as many
sets of scan points as may be desired, each for a different account type and
requirement
level. The definitions must be identical, however, for sets of combined
commodities
which have intercommodity spreads defined among them.
[00127] Calculation of risk array values: Generically, each risk array value
is
calculated as:
= the current value of the contract
= less the hypothetical future value of the contract, after the look-ahead
time has
passed, and (underlying) price and volatility movements associated with the
risk
scenario have occurred
= multiplied by the weight.
[00128] For futures, physicals and certain types of combinations, this change
in
value is determined by the price change alone.
[00129] To determin.e the hypothetical future value for options, the
underlying price
change, underlying volatility change, decrease in time to expiration, and the
associated
interest rates must also be taken into account, and a theoretical price
calculated using an
option pricing model.
[00130] In order to ensure that biases in the option pricing model do not
affect the
result, the current value may also be calculated using the same option pricing
model,
assuming the current tiune to expiration, current underlying price, and
current underlying
volatility. In other words, the risk array value for an option is determined
by subtracting
the hypothetical future theoretical value of the option, from the current
theoretical value
of the option.
[00131] The actual model selected, the parameters of the model, the interest
rates,
and the look-ahead time are all parameters of SPAN.
[00132] The composite delta, and delta point definitions: The composite delta
value is associated with each risk array defmed for a contract. The composite
delta is a
probability-weighted average of a set of deltas calculated for the contract
(a) after the
look-ahead time has passed and (b) according to the scenarios defined by the
definition of
the delta points.
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[00133] Delta points are defined exactly analogously to scan points, with a
price
scan magnitude, a volatility scan magnitude, and a weight. Suppose, for
example, that
there are seven delta points defined. Seven delta values are calculated for
the contract,
using the price scan magnitude and the volatility scan magnitude associated
with each
delta point, and assuming that the look-ahead time has passed. A weighted
average of
these deltas is then taken; using the weights specified in the delta point
definitions.
[00134] In effect, a composite delta value represents an estimate of what the
contract's delta will be after the look-ahead time has passed.
[00135] Overall SPAN process: To calculate SPAN requirements for a particular
portfolio defined at a particular point in time, in which particular business
functions for
particular exchanges or clearing organizations are represented:
= Obtain the applicable SPAN risk parameter file(s).
= Using the positions in the portfolio, and the data contained in the SPAN
files,
apply the SPAN algoritlun.
[00136] This yields the SPAN requirement:
= for the specific account type
= for each combined commodity of each business function represented in the
portfolio
= and for each combined commodity, for each applicable requirement level
(performance bond class, initial or maintenance designation).
[00137] Determining the set of requirement levels to be calculated for a
portfolio;
direct and indirect calculation: For a combined commodity in a portfolio of a
particular
account type, it is necessary to select the set of performance bond
requirement levels --
i.e., unique combinations of performance bond class and initial or maintenance
designation -- for which SPAN requirements should be calculated, directly or
indirectly.
[00138] A directly calculated SPAN requirement is a requirement, at a
particular
performance bond requirement level, for which the full SPAN calculation is
done -- i.e.,
scanning, spreading, etc.
[00139] An indirectly calculated requirement is one that is derived from
another
requirement, at a different requirement level, by the application of a simple
multiplicative
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scaling factor. Indirectly calculated requirements are also known as derived
requirements.
[00140] The selection of the set of requirement levels to be directly
calculated, for a
particular combined commodity in a portfolio, is driven by the set of
requirement levels
represented in the risk arrays for the products in that combined commodity. In
particular,
this is driven by which set of requirement levels are present for which
account types.
[00141] If there are risk arrays for this combined commodity for the
particular
account type of the portfolio, then these are the ones that determine the
requirement levels
to be directly calculated.
[00142] For example, suppose the portfolio is for a hedge customer, and in the
SPAN file for a particular combined commodity in the portfolio, one set of
risk arrays is
provided for hedge customers -- specifically, for the core maintenance
requirement level.
In this case one SPAN requirement level should be directly calculated -- the
hedge
customer core maintenance level.
[00143] On the other hand, suppose there were risk arrays for two requirement
levels for this account type -- for core maintenance and for core initial. In
that case we
would directly calculate separate SPAN requirements for these two levels.
[00144] On the other hand, if there are no risk arrays for this portfolio's
account
type, then one of the other account types for which risk arrays are present is
selected, and
SPAN requirements are calculated for the levels defined for this selected
account type.
[00145] Risk adjustment factors and derived requirements: For each combined
commodity, any number of risk adjustment factors may be provided in the SPAN
risk
parameter file.
[00146] Risk adjustment factors may be used either to adjust requirements at
directly calculated risk levels, or to derive requirements at other risk
levels (indirect
calculation.)
[00147] Each risk adjustment factor has the following defined for it:
= the account type to which it pertains
= the base requirement level, i.e., the requirement level -- performance bond
class
and initial or maintenance designation -- which will be used to derive another
one
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= the target requirement level -- the requirement level being adjusted or
derived
= the value of the factor
[00148] To apply a risk adjustment factor, simply multiply the requirement at
the
base level by the value of the factor.
[00149] Adjustment factors used to derive an initial requirement for a
particular
performance bond class from a maintenance requirement for that class are also
known as
initial to maintenance ratios.
[00150] The SPAN calculation, summarized:
[00151] A directly-calculated SPAN requirement at a particular requirement
level
for a combined commodity in a portfolio is calculated as:
= Sum the scan risk, the intracommodity spread risk, and the delivery (spot)
risk.
= Subtract the intercommodity spread credit.
= Take the larger of this result, and the short option minimum.
[00152] The scan risk is the risk for a combined commodity in a portfolio
assuming
perfect correlations in price and volatility movements of the underlying
instruments over
time.
[00153] The intracommodity spread risk allows the recognition of risk
associated
with spreading within the combined commodity -- so-called calendar spreads --
for
combined commodities where there is imperfect correlation of price and
volatility
movements over time, and allows precise targeting of these requirements to
particular
intracommodity strategies.
[00154] The delivery, or spot risk, recognizes the unique risk characteristics
of
physically deliverable products, and of derivatives based on such physically
deliverable
products, as they approach the delivery period or go through the delivery
process.
[00155] The intercommodity spread credit provides appropriate credits
recognizing
risk offsets between positions in the different combined commodities
represented in the
portfolio.
[00156] The short option minimum recognizes the unique characteristics of
short
option positions, and allows the recognition of a minimum risk value for deep
out-of-the-
money short options.
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[00157] The sum of the scan risk, intracommodity spread risk, and the delivery
risk
is often referred to as the commodity risk, i.e., it is the risk for the
combined commodity
in the absence of any credits for intercoinmodity spreading.
[00158] The result obtained by subtracting the intercommodity spread credit
from
the commodity risk is often referred to as the pre-SPAN risk. This value is
the directly
calculated SPAN requirement, assuming that the short option minimum
requirement is
less.
[00159] Products supported in SPAN: SPAN supports the widest possible range of
derivative and non-derivative product types. There is no product type that
cannot be
margined using SPAN.
[00160] Product terminology: The terms contract and product are used herein
interchangeably to refer to a specific tradable instrument -- physical or not,
derivative or
not -- in which positions to be margined may be held.
[00161] Clearing organizations, exchange groupings, and product families
[00162] At the highest level, products are cleared by clearing organizations.
[00163] Each clearing organization may have one or more exchange groupings
defmed for it.
[00164] Within each exchange grouping, products are grouped into product
families.
[00165] Generally, a product family is identified within an exchange grouping
by a
product code -- an alphanumeric value, for example, SP at the CMIE for
products related
to the S&P 500 stock index -- and a product type -- for example, futures,
options on
futures, etc.
[00166] Each product family is also assigned a product family ID number that
is
unique within the clearing organization and may be unique within the exchange
grouping.
[00167] Product families may be defined in as specific a manner as desired.
For
example, at the CME, other parameters used to make product families unique
include the
settlement method (cash-settled or physically deliverable), the valuation
method (futures-
style or equity-style), the settlement currency, and, for options, the
exercise style
(American or European). Contract size may also be used to as a factor, which
defines
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separate product families, although SPAN also supports the incli.tsion of
contracts of
different sizes in the same product family.
[00168] Contracts: In SPAN, tradable instruments, whether derivative or non-
derivative, are generically referred to as contracts or as products. As
described above,
contracts are grouped together in product families, and product type is always
one of the
things that makes a product family unique.
[00169] Product types and underlying product types: SPAN 4 allows the creation
of any number of product types. Product types may be for physicals or
derivatives and, if
the latter, for combination or non-combination products.
[00170] Each contract (product) which is not a physical of one or another type
is
classified as a derivative, and has one or more underlying contracts.
[00171] Derivative products that have exactly one underlying contract are
known as
non-combination derivatives.
[00172] For example, a futures contract has a single underlying contract,
called the
underlying physical. An option on a future has a single underlying contract,
the
underlying future. An option on a physical has a single underlying contract,
the
underlying physical.
[00173] Derivative contracts that have two or more underlying contracts are
generically known as combinations. Each such underlying is referred to as a
leg of the
combination.
[00174] For example, a combination, which is a futures calendar spread, would
have two underlying contracts -- the futures contract which is the front
contract of the
spread, and the futures contract which is the back contract of the spread.
[00175] At this time, SPAN recognizes three subtypes of the generic physical
type:
equity securities, debt securities, and debt securities margined on an
equivalent basis.
[001761 Swaps, repos and reverse repos are recognized as subtypes of the
combination type.
[00177] Contract structure and contract underlying ratios: The set of
underlying
contracts for a derivative product is known as its contract structure. Each
element in the
set specifies:
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= the specific underlying contract
= the underlying ratio for this specific underlying contract.
[00178] Underlying ratio may be defined as follows:
= For any contract X which is not a physical:
- For each of its underlying contracts Y;:
~ The underlying ratio is the nutnber of units of that underlying Y; which are
bought (or sold) per one long position of the contract X, expressed as a
positive number if buying, or a negative number if selling.
[00179] In other words, the underlying ratio tells you:
= whether buying the derivative means buying or selling this specific
underlying
contract, and
= how many of this specific underlying are bought or sold per purchase of one
derivative contract.
[00180] For example, the contract structure for a futures butterfly spread
would
specify that buying one spread means buying one of the first future, selling
two of the
second future, and buying one of the tllird future.
[00181] For example, a call option on 100 shares of stock. If you hold one
long
position in this call, and you exercise it, you receive (purchase) 100 shares
of stock.
Hence the underlying ratio is +100. On the other hand, if you own a put option
on 100
shares of stock, and you exercise it, you deliver (sell) 100 shares of stock.
Hence the
underlying ratio for this put option is -100.
[00182] Contract Price and Contract Value Calculations: Every contract, at
every
point in time, has a contract price associated with it.
[00183] For exchange-traded instruments, for SPAN being used as an end-of-day
tool for calculating performance bond (margin) requirements, this will be the
end-of-day
settlement price.
[00184] At other points in time -- for example, during the trading day -- this
may be
an intraday theoretical price.
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[00185] SPAN uses the price of a contract to determine the monetary value of a
single position in that contract -- the contract value. This monetary value is
expressed in
the settlement currency for the contract, also called the price quotation
currency.
[00186] To calculate contract value multiply the contract price by the
contract value
factor for the contract. The contract value factor is the multiplier, which
converts a
quoted price for the contract into its monetary value in the contract's
settlement currency.
[00187] (The contract value factor can in turn be derived from the
specification of
the contract size and the convention used for quoting prices. For example, for
the CME's
live cattle futures contract, the contract size is 40,000 pounds and the price
is quoted in
dollars per 100 pounds. Hence the contract value factor is 40,000 / 100 =
400.)
[00188] Contract periods: The concept of contract period is used in SPAN to
denote products with different maturities or expirations. Contract period can
be thought
of as a generalization of the contract month concept.
[00189] All contracts (except those that are margined on an equivalent basis)
have a
contract period code defined. Contract period codes may be six, seven, or
eight bytes in
length. The first six bytes consist of numeric digits. The seventh and eighth
bytes, if
defined, may consist of any alphanumeric character. A contract period code has
the
following structure:
= the four-digit year number -- for example, 1999
= the two-digit month number -- for example, 05 for May
= if needed, a two-byte string which may be used to further qualify the
contract
period.
[00190] Option Series: An option series in SPAN 4 consists of all options with
the
same expiration and the same underlying.
[00191] Standard options within a series, then, differ from each other only in
their
strike price and their option right -- i.e., whether they are puts or calls.
[00192] For more exotic options, such as barrier options, they may also be
distinguished by one or more barrier prices.
[00193] Participation of product families in business functions: A product
family is
said to participate in a particular business function, if it has been assigned
to one of the
combined commodities defmed for that business function.
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[00194] Every product family always participates in the normal clearing
business
function for its clearing organization. It may, but is not required to,
participate in
additional business functions.
[00195] Combined commodities and delta periods: The products assigned to a
combined commodity determine an array of delta periods defmed for that
combined
commodity. Each contract is mapped into a specific delta period, and delta
periods in
turn are mapped into tiers.
[00196] Tiers and Tiered Processing: A tier in SPAN is a contiguous range of
delta
periods within a combined commodity.
[00197] To provide the utmost flexibility, tiered processing is supported in
SPAN 4
for:
= scan rate tiers -- the specification of tiers for defining price scan ranges
and
volatility scan ranges
= scanning tiers
= intracommodity spread tiers
= intercommodity spread tiers
= short option minimum rate tiers
[00198] Specific tiers of a particular type for a combined commodity are
always
identified by a tier number beginning with one, and are further qualified by a
beginning
period code and an ending period code. The ending period code must be greater
than or
equal to the beginning period code, and the delta periods for the different
tiers never
overlap.
[00199] For intra- and inter-commodity spreading, sometimes there are cases
where
more than one tier is defined, but it is desired in a particular leg of a
spread to reference
the entire combined commodity, across all tiers. To support this, SPAN
recognizes for
each combined commodity an intracommodity spread tier zero and an
intercotnmodity
spread tier zero, which are defined as the range of period codes for the
entire combined
commodity, crossing individual tiers. This may also be referred to as the
overall tier.
[00200] One important aspect of SPAN 4's flexibility is the ability for
scanning tiers
and intercommodity spreading tiers to be defmed independently. Previously
there were
limitations on this ability.
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[00201] Mapping each delta period into its tier
[00202] For a given tier type for a combined commodity, to determine the tier
into
which a delta period maps:
= Compare the delta period code with the beginning period and the ending
period.
= If the delta period code is greater than or equal to the beginning period,
and less
than or equal to the ending period, then it maps into that tier.
[00203] Portfolios to be margined: As described above, a portfolio of
positions to
be margined using SPAN is held in an account. Each such account has a specific
account
type.
[00204] Portfolios may be defined at either the clearing-level or the customer-
level.
In other words, they are eitlzer for a specific performance bond account of a
clearing
member firm of a clearing organization, where the margin calculation is being
done by
that clearing organization, or they are for a specific customer-level account
of a meniber
firm or other trading firm, where the margin calculation is being done by that
firm.
[00205] A clearing-level portfolio always holds positions for a siilgle
business
function of that clearing organization, while any number of business functions
and
clearing organizations may be represented in the positions for a customer-
level portfolio.
[00206] Position defmition: A position within a portfolio to be margined at a
particular point in time, is defined by:
= the point in time at which the portfolio exists
= the portfolio in which the position is contained, specified as the firm
identifier, the
account identifier, the account type (including whether this is a clearing-
level or
firm-level account), and the segregation type
= the contract in which the position is held, and the business function for
which the
contract is to be margined, and
= the position quantity number(s).
[00207] For example, a particular position might be defined as:
= the end-of-day settlement for December 1, 1999
= firm 322, account XYZ, account type hedge customer, and segregation type
CUST (for Customer)
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= the CME's December 1999 S&P futures contract, to be margined for the normal
business function, and
= a net position of +17.
[00208] Gross and net position keeping: A gross position is one that may be
simultaneously long and short. A net position is one that is never
simultaneously long
and short.
[00209] In other words, a net position is one that is determined by netting
together
the beginning position for the day with all buys and sells for that day. For
net positions,
all trades are liquidating to the extent possible.
[00210] A gross position is deternlined by the beginning of day position and,
for
each trade done for that day, whether it was an opening (new) or closing
(liquidating)
transaction.
[00211] At the firm-level, accounts are commonly kept net, with two typical
exceptions: (1) omnibus accounts, discussed below, and (2) certain types of
hedger
accounts.
[00212] At the clearing level, positions are typically kept gross for accounts
which
themselves are aggregates of more than one account at the firm level, in order
to reflect
true open interest.
[00213] Net margining: At the firm-level and often at the clearing-level,
portfolios
are typically "net margined." This is also typically called "calculating a net
requirement."
This means two things:
= If the position is kept gross -- i.e., if the position may be simultaneously
long and
short -- then it is first netted before being processed in SPAN. Only the
portfolio
of net positions is margined.
= No restrictions are placed on the recognition of risk offsets between
different parts
of the portfolio.
[00214] Since SPAN does recognize all allowable risk offsets, as they are
defined in
the SPAN risk parameter file and as they are present in the portfolio, "net
margining"
translates into, process a portfolio of net positions via SPAN.
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[00215] Note that there is a distinction between gross and net position
keeping, and
gross and net margining: A position may be simultaneously kept gross, while
being
margined net. This is sometimes the case for certain types of hedge customer
accounts.
[00216] Omnibus accounts and levels of disclosure; gross margining at the firm
level: An oinnibus account is an account of one firm on another firm's books,
which
account is itself comprised of a number of individual accounts on the first
firm's books.
The firm with the omnibus account is said to carry the omnibus account on its
books, and
is often called the "carrying finn." The individual accounts on the first
firm's books are
said to be "subaccounts" of the omnibus account.
[00217] Because an omnibus account is comprised of any number of subaccounts,
omnibus account positions must be kept gross. Any given position in any
omnibus
account may itself be the sum of a number of subaccount positions, some of
which may
be long and some of which may be short.
[00218] If the omnibus account is "fully disclosed" to the carrying firm which
must
calculate a margin requirement for it, this means that it has informed the
carrying firm of
each individual subaccount and what its positions are. Depending on business
practices,
this may not mean that it has identified the owner of each subaccount, but
rather simply
that it is has specified which sets of positions belong to single owners.
[00219] In this case, the carrying finn typically calculates a net requirement
for
each subaccount, and the total omnibus account requirement is simply the sum
of the
subaccount requirements.
[00220] On the other hand, an omnibus account portfolio may be only "partially
disclosed", or "non-disclosed."
[00221] If partially disclosed, the omnibus account has provided information
to the
carrying firm about some sets of subaccounts, but not of all. If non-
disclosed, no
information is provided about the subaccounts and which positions they hold.
[00222] The portion of each gross omnibus account position which is not held
in
disclosed subaccounts, is typically said to be "naked". In other words, for
each position --
total long and total short -- there is a naked portion -- the naked long and
naked short.
[00223] These naked positions are typically "gross margined." This means that:
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= A separate SPAN requirement is calculated for each naked long position
quantity,
and for each naked short position quantity. Because each such position
quantity is
in a single contract, and is only on one side of the market, there are no risk
offsets
recognized in such requirements.
= The total requirement for the naked portion of the account portfolio is the
sum of
all of these individual naked long and naked short requirements.
[00224] If the omnibus account is partially disclosed, its total requirement
is the
sum of all of the net requirements for the subaccounts, plus the sum of all of
the
individual naked long and naked short requirements for the naked positions.
[00225] Gross-margining at the clearing level: At the clearing-level, the
overall
term "gross margining" is used to refer to a business practice where:
= Positions are kept gross - i.e. may be simultaneously long and short.
= Some portion of the total long and total short for each position is broken
out, and
margined net. This portion is termed the fully inter-commodity spreadable long
and short, and is often referred to as the "intercomm.odity spreadable" or the
"inter-
spreadable" long and short, or as just the "inter positions."
= Another portion of each total position is broken out, and margined net,
except that
no risk offsets are recognized among the different combined conunodities in
the
portfolio -- i.e., no intercommodity spreading is done. This portion is termed
the
"intracommodity spreadable", the "intra-spreadable" or as just the "intra
positions."
= The remaining portion of each total position is considered naked, and
margined
gross.
[00226] We say that some portion of the total positions has been deemed to be
spreadable both within commodities and between commodities, another portion to
be
spreadable only within commodities but not between commodities, and that a
final
portion to be spreadable not at all. The total SPAN requirement for each
combined
commodity in the clearing-level portfolio is then determined from the various
components of the SPAN requirements calculated for these different position
types.
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[00227] So at the clearing-level, "gross margining" doesn't mean that
positions are
fully gross margined, but rather that some portion of the overall positions
may be.
[00228] Clearing-level gross margining is typically used for customer-origin
performance bond accounts where the clearing-level positions are determined by
aggregating positions across many individual customer accounts. Typically, the
positions
within each customer account are inspected to determine whether risk offsets
exist both
within and between commodities, or only within commodities, or not at all.
Based on this
inspection, the customer's positions are classed as inter-spreadable, inter-
spreadable, or
naked. The total clearing-level inter-spreadable long and short positions,
then, are
calculated as the sum of the customer positions that were classed as inter-
spreadable, and
analogously for the intra-spreadable positions.
[00229] Position accounts, performance bond accounts, margin dispositions, and
positions to be margined
[00230] At the clearing-level, it is possible for a distinction to be drawn
between the
position accounts in which positions are kept, and the performance bond
accounts in
which they are margined.
[00231] In this case, there may be a great deal of flexibility in how
positions roll up
from position accounts to performance bond accounts.
[00232] For example, positions in products eligible for participation in a
particular
cross-margin agreement may be routed to a performance bond account
specifically for
that cross-margin business function, whereas positions in other products, not
eligible for
this cross-margin agreement, are routed to a performance bond account
specified as being
for the normal business fi.inction.
[00233] Even within a particular position, if that position is eligible for
more than
one business function, the position itself may be broken down into any number
of
"positions to be margined", or "dispositions", each of which is designated for
a particular
performance bond account and hence to be margined via the SPAN parameters for
a
specific business function.
[00234] For example, a total gross position of 1001ong and 200 short in a
product
eligible for a particular cross-margin agreement, might have dispositions for
it of 50 long
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and 75 short for the cross-margin business funetion, and 50 long and 125 short
for the
normal business function.
[00235] Within each disposition, the position-to-be-margined may be margined
either "gross" or net. If "gross", each total position-to-be-margined is
further broken
down into an inter-spreadable long and short, an intra-spreadable long and
short, and a
naked long and short. If "gross", as described above, the inter-spreadable
positions are
margined net, the intra-spreadable positions are margined net but without
allowing
intercommodity spreading, and the naked positions are truly margined gross.
[00236] The SPAN calculation for net portfolios: This section contains the
description of the detailed algorithm for calculation of a SPAN risk
requirement for each
combined commodity represented in a portfolio to be margined on a net basis --
a so-
called "net portfolio." This may be either a customer-level portfolio or a
clearing-level
portfolio.
[00237] Position processing: Position processing in SPAN consists of
processing
each position within each combined commodity represented in the portfolio, for
the
purposes of:
= Scaiming: scaling up the risk array(s) for the contract by the position
quantity, and
incrementing the overall risk array(s) by these scaled-up risk array(s)
= Delta calculation: scaling up the SPAN composite delta(s) for the contract
by the
position quantity, and incrementing the overall position delta(s) for the
associated
delta period by these scaled-up composite delta(s)
= Short option minimum calculation: determining the effect of the position on
the
quantity for determination of the short option minimum charge (also called the
minimum commodity charge).
= Position value calculation: evaluating the current monetary value of each
position,
and incrementing the overall current monetary values for the combined
commodity, broken out by whether the position is long or short and by whether
the
contract is valued futures-style or premium-style.
[00238] Position types for the position value calculations: Products can be
categorized by whether their valuation method is futures-style or premium-
style:
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= For futures-style products, there is a daily mark-to-market for open
positions, and
the resulting settlement variation amounts are paid or collected daily.
= For premium-style products, the full trade price (premium) is paid or
collected
when the position is opened.
[00239] Futures contracts, of course, are valued futures-style; the daily mark
to
market and the daily payment or collection for settlement variation (sometimes
called
"variation margin") is what distinguishes them from a forward contract.
[00240] Option positions are typically valued premium-style, but some exchange-
traded options are valued futures-style.
[00241] The significance of whether a position is valued premium-style is as
follows: If a position is valued premium style, and if the full value of the
premium is
considered to have been paid (or collected), then the current value of the
position is
counted as a collateral asset (if long) or a liability (if short).
[00242] For the positions in each combined commodity represented in the
portfolio,
then, it is necessary to determine the value of those positions broken out the
following
ways:
= by whether the positions are valued futures-style or premium-style
= by whether the position quantities are long or short
= by whether the positions are in options or are not in options.
[00243] In other words, for each combined coinmodity in the portfolio, we will
have determined:
= value of long non-option positions in products valued futures-style
= value of short non-option positions in products valued futures-style
= value of long option positions in products valued futures-style
= value of short option positions in products valued futures-style
= value of long non-option positions in products valued premium-style
= value of short non-option positions in products valued premium-style
= value of long option positions in products valued premium-style
= value of short option positions in products valued premium-style
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[00244] Note that in some cases, the exchange or clearing organization using
SPAN
may establish a business rule regarding the timing of the recognition of value
for
premium-style products. For example, suppose an unsettled trade for a stock
done for the
current business day is included in the portfolio of positions to be margined,
and that this
trade will settle three days subsequently. In this case, the clearing
organization might
decide not to give fiill or even partial credit for the premium value of this
trade until it has
settled and the full premium has been paid or collected. If so, the total
premium value
used for the purpose of determining whether a margin excess or deficit exists,
should be
adjusted by the amount of this premium value for which credit is not being
given.
[00245] Special position-processing features: In addition to regular position
processing, SPAN supports several special position-processing features which
provide
additional power and flexibility:
= Split Allocation is typically used for positions in combinations and/or
options on
combinations where the underlying instruments of the combination are in
different
physical commodities.
With this feature, the position in the combination or the option on the
combination, is split out (allocated) into positions on the underlying
instruments of
the combination.
= Delta-Split Allocation is typically used for positions in combinations
and/or
options on combinations where the underlying instruments of the combinations
are
at different expirations within the same physical commodity.
This is similar to regular split allocation, but differs in that only the
delta from the
position in the combination or the option on the combination, is split out to
the
delta periods of the underlying legs.
= Equivalent Positions is used when it is desired to margin a position in one
instrument, as one or more equivalent positions in other instruments.
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[00246] Expression of Net Position Numbers: For positions in a net portfolio,
position quantities are expressed as signed numbers, positive for a net long
position, and
negative for a net short position.
[00247] Depending on the types of instruments in the portfolio and the
conventions
used for expressing their positions, it is possible for position quantities to
be fractional --
i.e., not whole numbers.
[00248] Pre-Processing for Margining Debt Securities on an Equivalent Basis:
For
positions in physical debt securities, which are being margined on an
equivalent basis, it
may be necessary to perform special pre-processing to express the position
quantities
properly, even before the transformation of the debt securities position into
its
equivalents. This section describes that pre-processing.
[00249] For government debt securities to be margined on an equivalent basis,
positions should be expressed in units of thousands of par value currency
units in the
currency of denomination. For example, a position in a U.S. Treasury Bond with
a face
value of $1,000,000 should be expressed as 1,000.
[00250] Positions to be margined in such physical debt securities are those
resulting
froni not-yet-settled trades. The actual position in such securities can
sometimes be
broken out as the sum of:
= the net position from open outright trades, and
= the net position from open repos (or reverse repos) in which the on-leg has
settled
but the off-leg has not yet settled, with a net repo position expressed as a
positive
number and a net reverse repo position expressed as a negative number. Such
repos are referred to as same-day repos when they are entered into (and
margined),
since on the day they are entered into, the on-leg settles, leaving only the
unsettled
off leg to be margined.
[00251] Repo and reverse repo positions where neither leg has settled are
typically
considered to be next-day repos. In other words, the repo is entered into
today, with the
on-leg beginning tomorrow. Since the on-leg and the off-leg are both not-yet-
settled,
these obligations cancel each other out. So these next-day repo or reverse
repo positions
are not included in the margin calculation.
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[00252] Processing Split-Allocation Positions: After transforming any
positions to
be processed on an equivalent basis into their equivalents, the next step in
position
processing is to deal with any positions that are to be handled using the
split allocation
method.
[00253] As described above, split allocation is typically used for positions
in
options on futures intercommodity spreads. The method is generically
applicable,
however, to any combination product or option on combination product.
[00254] The specification of whether split allocation is to be performed is
done for
a product family linked into a combined commodity. Not all product families
linked into
a combined commodity need be processed using split allocation. In general,
however, for
the algorithm to yield the desired results, split allocation should be
specified for both the
options on the combination, and the combination itself. Typically both of
these product
families will be placed into the same combined commodity.
[00255] Determining position quantities for further processing: With positions
to
be processed on an equivalent basis transformed into their equivalents, and
positions to be
processed via split allocation, allocated out to their underlyings, we're now
ready to
determine the position quantities to be carried forward in SPAN.
[00256] The following applies to all position types except positions processed
on an
equivalent basis. (As explained above, such positions play no additional role
in the
calculations once they have been transformed into their equivalents.)
[00257] The algorithm will evaluate five different values for each position:
= the total position
= the marginable position
= the position for valuation
= the position for scanning
= the positions for the short option minimum calculation -- the number of
short calls
and the number of short puts
[00258] For each position in the portfolio:
- The total position is equal to the sum of the position in the contract
itself, the
equivalent position, and the position resulting from split allocation.
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- The marginable position is equal to the total position times the contract-
scaling
factor.
- The position for valuation is the sum of the position in the contract itself
and the
rounded position resulting from equivalents.
- The position for scanning is determined as follows:
~ If the product family for this position is processed either normally or via
delta-
split-allocation, take the marginable position.
~ If the product family for this position is processed via split allocation,
take
zero.
- The positions for the minimum commodity charge are determined as follows:
~ If this position is not for an option, then the number of short calls and
the
number of short puts are both zero.
~ But if this position is for an option:
= If the marginable position is zero or positive, then the number of short
calls
and the number of short puts are both zero.
= But if the marginable position is negative:
= If the option is a call, the number of short calls is equal to the absolute
value of the product of the marginable position and the delta-scaling
factor. The number of short puts is zero.
= If the option is a put, the number of short puts is equal to the absolute
value of the product of the marginable position and the delta-scaling
factor. The nutnber of short calls is zero.
[00259] Determiiiing the Position Value: For each combined commodity in the
portfolio:
- For each position in the portfolio:
= Take the position for valuation as determined above.
= Multiply this result by the value of a single contract, yielding the value
of the
position in the settlement currency for the contract.
= If the performance bond currency for the combined commodity in which the
product is contained is different from the settlement currency of the product,
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convert the value from the settlement currency to the performance bond
currency, rounding as may be needed to the normal precision of the
performance bond currency. This yields the value of the position in the
performance bond currency for the combined commodity.
[00260] Determining the Liquidation Risk Position Value: The Liquidation Rislc
calculation is a method of determining the Scan Risk, which has been
introduced in
SPAN for the Paris Bourse (SBF.) This calculation requires the determination
of a
special position value called the Liquidation Risk Position Value. As can be
seen, this
differs from the regular position value in that (a) it includes any position
quantity
resulting from split allocation, and (b) for positions in debt securities, it
is adjusted for the
duration of the security.
[00261] For each combined commodity in the portfolio for which "liquidation
risk"
has been specified as the method for determining the scan risk:
- For each position for products linked into this combined commodity:
~ Take the position for scanning, as determined above.
~ If this position is in a debt security, inultiply this value by the duration
of that
security, expressed in years.
= Multiply this result by the value of a single contract.
~ If the performance bond currency for the combined commodity in which the
product is contained is different from the settlement currency of the product,
convert this value from the settlement currency to the performance bond
currency.
~ Round this result as specified. (The rounding convention used by SBF for
liquidation risk position value is to round down -- toward zero -- to five
decimal places.) The result is the liquidation risk position value.
[00262] Determining the Currency Conversion Rates for the Intercurrency Risk
Scanning feature of the Scan Risk calculation: Intercurrency risk scanning is
an optional
feature of the scan risk calculation which may be applied in cases where there
are
products whose settlement currency is different from the performance bond
currency of
the combined commodity into which they are linlced.
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[00263] When a product family is linked into a combined commodity, it may be
specified that intercurrency risk scanning is applicable.
[00264] If intercurrency risk scanning is specified, then the risk array
values for that
product family linked into that combined commodity are denominated in the
settlement
currency for that product family.
[00265] For each such settlement currency and performance bond currency pair,
it
is necessary to determine the exchange rate up and the exchange rate down:
= For a given settlement currency and performance bond currency pair, read the
intercurrency scan rate up and the intercurrency scan rate down. (These are
provided
in the London format SPAN file on the currency conversion rate record for that
currency pair.) Express these values as decimal fractions. If the settlement
currency
is equal to the performance bond currency, take zero for these values.
= Take the exchange rate multiplier, wllich converts a value in the settlement
currency
to one in the performance bond currency. If the settlement currency is equal
to the
performance bond currency, take one for this value.
= Multiply the exchange rate by the value of one plus the intercurrency scan
rate up,
yielding the exchange rate up.
= Multiply the exchange rate by the value of one minus the intercurrency scan
rate
down, yielding the exchange rate down.
[00266] Determining the Scaled-Up Risk Array(s) and Delta(s) for the Position:
For each combined commodity in the portfolio for which scanning is being
performed
normally (not using the "liquidation risk" scanning method):
- For each product family in this combined commodity:
~ For each position in this product family:
= Take the position for scanning as detennined above.
= For each directly calculated requirement level for this portfolio type and
combined commodity:
= Talce the risk array for this product as linked into this combined
commodity and for this requirement level.
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= Multiply each element in the risk array by the position for scanning,
yielding the scaled-up risk array for the position.
= If the intercurrency risk scanning feature is enabled for this product
family:
- Multiply each element in the scaled-up risk array by the exchange
rate up for this settlement currency / performance bond currency
pair, yielding the scaled-up converted-up risk array.
- Multiply each element in the scaled-up risk array by the exchange
rate down for this settlement currency / performance bond currency
pair, yielding the scaled-up converted-down risk array.
= To determine the position delta:
- Take the composite delta for this product as linked into this
combined commodity and for this requirement level.
- Multiply the position for scanning by the composite delta and then
by the delta-scaling factor.
[00267] Aggregation of position values to the combined commodity: For each
combined commodity in the portfolio:
- For each position in the combined commodity:
~ Talce the position value as calculated above.
~ Using the position value, increment one of eight value buckets for the
combined coinmodity determined according to whether:
= The position value is long (positive) or short (negative).
= The position is for an option or a non-option.
= The position is valued futures-style or premium-style.
[00268] Aggregation of short option positions: For each combined commodity in
the portfolio:
- For each position in the combined commodity:
~ For each short option minimum rate tier for the combined commodity:
= Increment the number of short calls for the overall tier by the number of
short calls for the position as calculated above.
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= Increment the number of short puts for the overall tier by the number of
short puts for the position as calculated above.
[00269] Determining the Number of Short Option Positions for a Tier: If the
short
option minimum charge method for the combined conumodity is gross:
- Take the sum of the number of short calls for the tier and the number of
short puts
for the tier.
[00270] If the short option minimum charge metliod for the combined commodity
is
maximum:
- Take the larger of the number of short calls for the tier and the number of
short
puts for the tier.
[00271] Determining the Short Option Minimum Charge: For each combined
commodity in the portfolio:
- For each directly calculated requirement level:
~ For each short option minimum rate tier
= Determine the number of short option positions for the tier.
= Multiply by the short option minimum charge rate to yield the charge for
the tier.
= Take the sum of the charges for the specific tiers, yielding the overall
charge for the combined commodity.
[00272] Aggregation of scaled-up risk array values to the scanning tier(s) and
the
intercommodity spread tier(s): For each combined commodity in the portfolio
for which
scanning is being performed normally (not using the "liquidation risk"
scanning method):
- For each position in the combined commodity:
~ For each directly calculated requirement level for the portfolio:
= If intercurrency risk scanning is not enabled for the product family for
this
position in this combined commodity:
= Increment each element in the overall scanning tier rislc array, by the
corresponding element in the scaled-up risk array for the position.
= If there are specific scanning tiers for the combined commodity, select
the specific scanning tier in which this product is contained, and
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increment each element in the risk array for the specific tier, by the
corresponding element in the scaled-up risk array for the position.
= Increment each element in the overall intercommodity spread tier risk
array, by the corresponding element in the scaled-up risk array for the
position.
= If there are specific intercommodity spread tiers for the combined
commodity, select the specific intercommodity spread tier in which this
product is contained, and increment each element in the risk array for
the specific tier, by the corresponding element in the scaled-up risk
array for the position.
= But if intercurrency risk scanning is enabled for the product family for
this
position in this combined commodity:
= Increment each element in the overall scanning tier exchange rate up
risk array for this settlement currency / performance bond currency pair,
by the corresponding element in the scaled-up exchange rate up risk
array for the position.
= Increment each element in the overall scanning tier exchange rate down
risk array for this settlement currency / performance bond currency pair,
by the corresponding element in the scaled-up exchange rate down risk
array for the position.
= If there are specific scanning tiers for the combined commodity, select
the specific scanning tier in which this product is contained, and:
- Increment each element in the exchange rate up risk array for the
specific tier for this settlement currency / performance bond
currency pair, by the corresponding element in the scaled-up
exchange rate up risk array for the position.
- Increment each element in the exchange rate down risk array for the
specific tier for this settlement currency / performance bond
currency pair, by the corresponding element in the scaled-up
exchange rate down risk array for the position.
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= Increment each element in the overall intercommodity spread tier
exchange rate up risk array for this settlement currency / performance
bond currency pair, by the corresponding element in the scaled-up
exchange rate up risk array for the position.
= Increment each element in the overall intercommodity spread tier
exchange rate down risk array for this settlement currency /
performance bond currency pair, by the corresponding element in the
scaled-up exchange rate down risk array for the position.
= If there are specific intercommodity spread tiers for the combined
commodity, select the specific intercommodity spread tier in which this
product is contained, and:
- Increment each element in the exchange rate up risk array for the
specific tier for this settlement currency / performance bond
currency pair, by the corresponding element in the scaled-up
exchange rate up risk array for the position.
- Increment each element in the exchange rate down risk array for the
specific tier for this settlement currency / performance bond
currency pair, by the corresponding element in the scaled-up
exchange rate down risk array for the position.
[00273] Aggregation of position delta to the delta periods: For each combined
commodity in the portfolio for which scanning is being performed normally (not
using
the "liquidation risk" scanning method):
- For each position in the combined commodity:
~ For each directly-calculated requirement level for the combined commodity:
= Take the position delta. (If the position is being processed via split
allocation, the position delta will be zero and there is no need to continue.)
= If the product is processed normally, increment the period delta for this
requirement level and for the delta period containing this contract, by this
position delta.
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[00274] If the product is processed using delta-split-allocation, allocate the
position
deltas out to the underlying(s) Initialization of Tier Deltas
[00275] For intracommodity spread tiers:
= For each combined commodity in the portfolio:
- For each directly calculated requirement level:
= For each intracommodity spread tier:
= Initialize the total long delta for the specific tier by taking the sum of
all
period deltas contained within the tier which are positive (i.e., net long.)
= Initialize the total short delta for the specific tier by taking the sum of
all period deltas contained witliin the tier which are negative (i.e., net
short), and then by taking the absolute value of this result.
= For the overall tier:
= Initialize the total long delta for the overall tier by taking the sum of
the
total long deltas for the specific tiers.
= Initialize the total short delta for the overall tier by taking the sum of
the total short deltas for the specific tiers.
[00276] For intercommodity spread tiers:
= For each combined commodity in the portfolio:
- For each directly calculated requirement level:
= For each intercommodity spread tier:
= Initialize the total long delta for the specific tier by taking the sum of
all
period deltas contained within the tier which are positive (i.e., net long.)
= Initialize the total short delta for the specific tier by taking the sum of
all period deltas contained within the tier which are negative (i.e., net
short), and then by taking the absolute value of this result.
= Net these two results against each other: subtract the total short delta
from the total long delta. If the result is positive, store it as the total
long delta and set the total short delta to zero. If the result is negative,
take its absolute value, store it as the total short delta, and set the total
long delta to zero.
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= For the overall tier:
= Initialize the total long delta for the overall tier by taking the sum of
the
total long deltas for the specific tiers.
= Initialize the total short delta for the overall tier by taking the sum of
the total short deltas for the specific tiers.
= Net these two results against each other: subtract the total short delta
from the total long delta. If the result is positive, store it as the total
long delta and set the total short delta to zero. If the result is negative,
take its absolute value, store it as the total short delta, and set the total
long delta to zero.
[00277] Determining the Scan Risk and Related Values for Scanning and
Intercominodity Spreading Tiers: For each combined commodity in the portfolio
for
which scanning is being performed normally (not using the "liquidation risk"
scanning
method):
- For the overall scanning tier, for the overall intercommodity spreading
tier, for
each specific scanning tier if there are any, and for each specific
intercommodity
spreading tier if there are any:
~ For each directly calculated requirement level:
= If intercurrency risk scanning was enabled for any product family in this
combined coinmodity:
= For each settlement currency / performance bond currency pair for this
combined commodity represented among the set of product families for
which intercurrency risk scanning was enabled:
- Compare each element in the exchange rate up array with the
corresponding element in the exchange rate down array. For each
element, select the larger value (more positive or less negative),
thereby yielding the overall risk array for this tier and currency pair.
= Sum the overall risk arrays for the various currency pairs for the tier,
together with the array for the tier for products for which intercurrency
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risk scanning was not enabled (if any), thereby yielding the overall risk
array for the tier.
= Select the largest (most positive) value in the risk array. This is the
largest
loss for the tier, and the corresponding risk scenario is called the active
scenario. For scanning tiers only, this value is also called the scan risk for
the tier.
= For intercommodity spread tiers only:
= Select the risk array value with the same definition for price movement
as the active scenario, but the opposite definition of volatility
movement. This is called the paired point.
= Take the average of the risk array values for the active scenario and the
paired point. Round this result as specified in the rounding convention
for time and volatility risks for this exchange complex, yielding an
estimate of the volatility risk for the tier.
= Take the two risk array values with scenario definitions of (a) no price
change and (b) opposite volatility changes. Take the average of these
two values, yielding an estimate of the time risk for the tier.
= Subtract the estimates of volatility risk and time risk from the scan risk,
yielding an estimate of the price risk.
= Calculate the weighted price risk for the tier via one of three weighted
price risk calculation methods.
1002781 Determining the weighted price risk for an intercommodity spread tier:
There are three methods for calculating the weighted price risk for an
intercommodity
spread tier: normal, normal with capping, and scanrange.
[00279] If the method is normal:
- Subtract the value of the short delta for the tier from the value of the
long delta for
the tier, yielding the net delta for the tier.
- Divide the price risk for the tier by the net delta.
- Take the absolute value of this result.
[00280] If the method is scanrange:
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- Select the first non-option contract within the tier that has a non-zero
value for its
price scan range.
- Take that price scan range.
- Divide that value by the product of the contract's contract scaling factor
and delta-
scaling factor. (This takes relative contract size differences into account,
converting the value into one applicable to a "standard" sized contract.)
[00281] If the method is normal with capping:
- Calculate the weighted price risk first via the normal method, and again via
the
scanrange method.
- Take the smaller of these two values. (In effect, it is calculated normally,
but its
value is capped at the scan range.)
[002821 Determining the Scan Risk for the Combined Commodity: For each
combined cominodity within the portfolio for which scanning is being performed
normally (not using the "liquidation risk" scanning method):
- For each directly calculated requirement level for that combined commodity:
~ If there are any specific scanning tiers defined for the combined
conunodity:
= The scan risk for the combined conunodity is the sum of the tier scan risks
for each specific scanning tier.
~ But if there is only the overall scanning tier for the combined commodity:
= The scan risk for the combined commodity is the scan risk for that overall
scanning tier.
[00283] Determining the Scan Risk and setting other values for the Combined
Comn7odity using the Liquidation Risk Method: Each combined commodity for
which
Liquidation Risk has been specified as the processing method for scanning will
contain
only physical equity or debt securities which are considered to (a) be within
the same
security family and (b) have the same risk level.
[00284] Each such combined commodity will have only overall tiers defined for
it
for scanning, for intercommodity spreading, and for intracommodity spreading.
[00285] Each such combined commodity will have precisely one intracommodity
spread defined for it, a delta-based, one to one, overall tier 1 to overall
tier 1 spread. The
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charge rate for this spread will be specified as a decimal fraction.
Intercornmodity
spreads referencing this combined commodity will similarly reference the
overall
intercommodity spread tier, with a credit rate specified as a decimal
fraction.
[00286] For each combined commodity for which Liquidation Risk has been
specified as the method for determining the Scan Risk:
- Take the sum of the Liquidation Risk Position Values for all positions for
which
this value is positive. This yields the Long Liquidation Value.
- Take the sum of the Liquidation Risk Position Values for all positions for
which
this value is negative. Then take the absolute value of this sum. This yields
the
Short Liquidation Value.
- For each directly-calculated requirement level for this combined commodity:
~ Read the Liquidation Risk rates for this requirement level and combined
commodity. There will be two values, the Specific Rate and the Generic Rate.
(These are also referred to as the X-parameter and the Y-parameter,
respectively, in the Paris Bourse documentation.)
~ Take the sum of the Long Liquidation Value and the Short Liquidation Value,
and multiply this result by the Specific Rate. This yields the Specific Risk.
~ Talce the absolute value of the difference between the Long Liquidation
Value
and the Short Liquidation Value, and multiply this result by'the Generic Rate.
This yields the Generic Risk.
~ Take the sum of the Specific Risk and the Generic Risk.
~ Store the Long Liquidation Value as the Long Delta for the overall
Intracommodity Spread Tier.
~ Store the Short Liquidation Value as the Short Delta for the overall
Intracommodity Spread Tier.
~ Subtract the Short Liquidation Value from the Long Liquidation Value. If
this
result is zero or positive, store it as the Long Delta for the overall
Intercommodity Spread Tier. If this result is negative, talce its absolute
value
and store it as the Short Delta for the overall intercommodity spread tier.
~ Set the Weighted Price Risk for the overall intercommodity spread tier to 1.
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[00287] Spreading: After determining the scan risk and the minimum commodity
charge for each combined commodity in the portfolio, the next step is to
perform
spreading. As will be described below, the disclosed embodiments utilize the
following
spreading and hybrid spreading methodologies.
[00288] Spread groups: The SPAN algorithm supports the defuiition of the
following groups of spreads:
= Super-intercommodity spreads
= Intra-commodity spreads
= Pre-crossmargining spreads
= Cross-margining spreads
= Inter-conunodity spreads
= Inter-clearing organization ("interexchange") spreads
[00289] Intra-commodity spreads and inter-commodity spreads are the most
familiar types.
[00290] Intra-conunodity spreads are typically used to calculate charges to
recognize the risk associated with spreads formed within a combined commodity.
These
can be needed since the scanning process assumes perfect correlation of price
movements
among the various products grouped together within a combined commodity.
[00291] Inter-commodity spreads are used to recognize risk offsets, and
provide
appropriate credits, between positions in related combined commodities.
[00292] Inter-clearing organization spreads, often referred to as
interexchange
spreads, are used to recognize risk offsets and provide appropriate credits,
between
positions in combined commodities of different clearing organizations or other
business
functions of those clearing organizations. These are distinguished from normal
intercommodity spreads in that each clearing organization involved in a
particular spread
is free to recognize or not recognize that spread, and to specify the
particular credit rate
applicable to its own products. This may be used when a clearing organization
wishes to
grant a reduction to the performance bond requirement for its own products
when the risk
of those products is reduced by offsetting positions on another clearing
organization,
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regardless of whether any formal cross-margining agreement exists between
those
clearing organizations, and typically in the absence of any such agreement.
[00293] Super-intercommodity spreads are a new spread group created in order
to
allow the recognition of particular delta patterns across combined
cominodities, even
before intracommodity spreading is performed. For example, this type of spread
can be
used to recognize a "tandem" relationship between two combined commodities
(for the
first combined commodity: long in one month, short in another; and for the
second
combined commodity: short in one month, long in another.)
[00294] Cross-margining spreads are a new group created in order to allow two
or
more clearing organizations which participate in a cross-margin agreement, to
defme
spreads which are to be evaluated before normal intra- and inter-commodity
spreading is
done. The new pre-cross-margining spread group gives those same clearing
organizations
an opportunity to define spreads which are to be evaluated first, before the
cross-
margining spreading is done.
[00295] Spread types: In addition to the spread group in which they are
contained,
spreads may be categorized by whether they are delta-based, scanning-based, or
hybrid
delta-based / scanning-based.
[00296] Scanning-based spreads and hybrid spreads can only be used for the
intercommodity spread groups -- pre-crossmargin spreads, super-intercommodity
spreads,
and normal intercommodity spreads.
[00297] Spreads in the groups that cross clearing organization and/or business
function boundaries -- the crossmargining spreads and the inter-clearing
organization
spreads -- can only be delta-based.
[00298] Delta-Based Spreading: A delta-based spread is one that is formed on a
delta-basis - i.e., according to the relative magnitudes and relationships of
the remaining
delta values for each of the legs of the spread.
[00299] A delta-based spread may contain any number of spread legs. Spreads
are
typically two-legged, but three, four, five or more legged-spreads may occur.
[00300] Each leg references a specific combined commodity, and for that
combined
commodity, one of:
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= an intercommodity spread tier
= an intracommodity spread tier, or
= a delta period.
[00301] In addition, for each leg, a delta per spread ratio and a relative
market side
indicator are specified.
[00302] The delta per spread ratio is a positive value, which indicates the
amount of
delta consumed for that leg via the formation of one spread.
[00303] The relative market side indicator is either A or B, and indicates the
relative relationship of the remaining deltas of the legs which must prevail
in order for
spreads to be formed. For example, for a typical two-legged A to B spread,
either the
remaining delta for the first leg must be positive and the second leg
negative, or the
remaining delta for the first leg must be negative and the second leg
positive.
[00304] A delta-based spread also has defined for it a charge or credit method
--
either flat-rate, or weighted price risk:
= Flat-rate is typically used for intracommodity spreads. A charge for the
spread is
calculated by taking the number of spreads formed and multiplying by the
charge
rate.
= Weighted price risk is typically used for intercommodity spreads. For each
participating leg, a credit for the spread is calculated by determining the
total
number of delta consumed by the spread, times the weighted price risk (which
can
be thought of as the price risk per delta), times the credit rate percentage.
[00305] Accordingly, a delta-based spread also has defined for it one or more
rates,
depending on how many requirenient levels are being directly calculated.
[00306] For an intracommodity spread using the flat-rate method, the rates are
considered to be charge rates, and a normal, positive charge rate produces an
intracommodity spread charge. A negative charge rate is allowed and would
produce a
negative charge - i.e., a credit.
[00307] Similarly, for an intercommodity spread using the weighted price risk
method, a normal, positive credit rate percentage produces a positive credit
amount. If a
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negative credit rate had been specified for the spread, this would yield a
negative credit -
i.e., a charge.
[00308] Delta-based spreads using the flat rate method may have more than one
combined commodity represented among their legs. If so, the resulting charge
is
apportioned to each leg according to the relative proportion of the absolute
value of its
delta per spread ratio. All such combined commodities participating in such a
spread
must accordingly share the same performance bond currency.
[00309] Spreads within spreads: Sometimes it may be desired to use one delta-
based spread to set a limit on the total number of spreads formed via a
separate set of
delta-based spreads.
[00310] To handle these situations generically, delta-based spreads have been
made
recursive in SPAN.
[00311] That is, a delta-based spread may contain a set (one or more) of delta-
based
spreads, each of which may contain a set (one or more) of delta-based spreads.
There are
no limits to the numbers of levels of such recursions.
[00312] The spread at the top of such a hierarchy is called the top-level
spread, and
it is the one that contains the rate(s) for the spread. Spreads at lower
levels do not have
rates defined for them.
[00313] The basic idea here is that each spread sets an upper bound on the
number
of spreads which can be formed by spreads contained within it. In the typical
case, there
is only one level of recursion, with a top-level spread containing a set of
child spreads,
each of which does not have children. In this case, the top-level spread sets
an overall
upper bound on the number of spreads formable by its child spreads.
[00314] Creating the combined pools of inter-clearing organization spreads and
of
crossmargining spreads
[00315] Except for spreads in the crossmargining group and the inter-clearing
organization group, spreads in each group are evaluated exchange complex by
exchange
complex, and it does not matter in which order the exchange complexes are
processed.
[00316] For the crossmargining group and the inter-clearing organization
group,
however, processing is not done by exchange complex. Instead, single pools of
spreads
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are created which include all spreads provided for any exchange complex
represented in
the portfolio. This process has several important characteristics:
= Duplicate spreads are recognized: suppose, for example, that clearing
organization X recognizes a 1 to 1, A to B spread for one of its products
against a
related product on clearing organization Y. Suppose further that clearing
organization Y recognizes the same spread against clearing organization X.
In this case, the algorithm must recognize that these are the same spread.
= Each clearing organization can only provide a credit for its own products.
In this
example, when clearing organization X specifies the spread, the credit rate(s)
it
specifies only apply to its own products. And similarly for clearing
organization
Y.
If clearing organization X recognizes the spread while organization Y does
not,
then the credit rate specified by X will apply only to X's products. Y's
products
will have a credit rate of zero.
If both organizations recognize the spread, there nevertheless is no guarantee
that
they will have the same credit rates. X may specify one rate applicable to its
products, and Y may specify a different rate applicable to its products.
= Spreads are prioritized by greatest total savings. The spreads in the
combined pool
must be prioritized according to greatest total savings across all legs.
[00317] Evaluating spreads group by group: For each exchange complex in the
portfolio:
- For the spreads in the super-intercommodity spread group:
~ Evaluate each spread within the group in turn, in order by spread priority.
[00318] For each exchange complex in the portfolio:
- For the spreads in the intracommodity spread group:
~ Evaluate each spread within the group in turn, in order by spread priority.
[00319] ~ Finalize the spot charges for all delta periods to which they apply.
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[00320] For each exchange complex in the portfolio:
- For the spreads in the pre-crossmargining spread group:
~ Evaluate each spread within the group in turn, in order by spread priority.
[00321] For the combined pool of crossmargining spreads:
- Evaluate each spread in the pool, ordered as described above in descending
order
by total savings.
[00322] For each exchange complex in the portfolio:
- For the spreads in the intercommodity spread group:
~ Evaluate each spread within the group in turn, in order by spread priority.
[00323] For the combined pool of inter-clearing organization spreads:
- Evaluate each spread in the pool, ordered as described above in descending
order
by total savings.
[00324] Evaluating a delta-based spread - Overview: The overall process for
evaluating a delta-based spread that has no child spreads can be summarized as
follows:
[00325] First, check to make sure that each of the spread legs is present in
the
portfolio.
[00326] Then attempt to fonn spreads under each of the two possible
assumptions
of market side. In other words, first attempt to form spreads assuming that
the "A" legs
are long and the "B" legs are short. Then reverse the assumption and attempt
to form
spreads assuming that the "A" legs are short and the "B" legs are long.
[00327] Under either assumption, if any spreads can be formed, detennine for
each
leg the delta consumed by the spread. Remove the consumed delta from the
remaining
delta for that spread leg. Then re-evaluate delta values as needed so that
remaining period
deltas, intraconrnmodity spread tier deltas, and intercommodity spread tier
deltas are kept
synchronized.
[00328] Last, determine the charge or credit associated with the spreads
formed.
[00329] Determining the delta consumed for a particular leg of a delta-based
spread
under a particular assumption of market side:
= Take the number of spreads formed.
= Multiply by the delta per spread ratio for the leg.
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= If the current assumption is that the A side is long and this is a B leg, OR
if the current
assumption is that the A side is short and this is an leg, then multiply the
above result
by -1 to make it negative. (In other words, in this case, short delta has been
consumed.)
[00330] Removing the delta consumed for a particular leg of a delta-based
spread
under a particular assumption of market side:
= Initialize the remaining delta to be removed, as the delta to be consumed.
:= If the leg references a spread tier -- either an intracommodity or an
intercommodity
spread tier, and either a specific tier or the overall tier:
- Beginning with the first delta period within the tier and continuing with
each
subsequent delta period within the tier, remove delta from each such period
sequentially until remaining delta to be removed is zero.
6:= But if the leg references a specific delta period, then remove delta from
that specific
period.
:= For each intracom.modity or intercommodity spread tier containing the
period from
which some delta was removed decrement remaining long or short delta by the
amount of delta removed from the period.
[00331] Calculating the credit for a particular leg of a delta-based spread
which
uses the weighted price risk metliod, and incrementing the credit amount for
the
appropriate tier: This would be for a delta-based spread that uses the
weighted price risk
method. Each leg of such a spread would reference either an intercommodity
spread tier
or a delta period for a combined commodity. If the leg references a tier, it
wi11 be either
the overall intercommodity spread tier or, if specific tiers are defined, a
specific
intercommodity spread tier.
= Take the absolute value of the delta consumed by the spread for this leg.
= Determine the tier to use for reading the weighted price risk:
- If the leg references an intercommodity spread tier, select that tier.
- If the leg references a delta period:
~ If specific intercommodity spread tiers are defmed, select the specific tier
containing this period.
~ If no specific tiers are defined, select the overall intercommodity spread
tier.
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- Take the absolute value of the delta consumed by the spread for this leg and
this
requirement level.
- Multiply this result by the weighted price risk for the selected tier and
this
requirement level.
- Multiply this result by the credit rate for the spread for this leg and this
requirement
level.
- If the spread giving rise to this credit is in any spread group other than
the cross-
margin spread group or the inter-clearing organization spread group:
~ Increment the intercommodity spread credit for the selected tier, by the
credit
for this leg for this spread.
- But if the spread giving rise to this credit is in either the cross-margin
spread group or
the inter-clearing organization spread group:
~ Increment the inter-clearing organization spread credit for the selected
tier, by
the credit for this leg for this spread.
(As described above, if the credit rate were negative, this would yield a
negative credit --
i.e., a charge.)
[00332] Calculating the charge for a delta-based spread which uses the flat-
rate
method: This could apply to a pre-crossmargining spread, a super-
intercommodity
spread, an intracommodity spread, or an intercommodity spread.
=e= Take the number of spreads formed.
+.- Multiply by the charge rate for the spread for this requirement level.
[00333] Scanning-Based Spreads: Scanning-based spreads are inherently
intercommodity spreads, and can only be present within the three spread groups
which (a)
include more than one combined commodity among the legs and (b) do not cross
exchange complexes. These groups are: pre-crossmargin spreads, super-
intercommodity
spreads, and normal intercommodity spreads.
[00334] A scanning-based spread is similar to a delta-based spread in that it
contains a collection of legs. Each leg, however, references only a specific
combined
commodity.
[00335] The relative market side indicator is not applicable to the legs of a
scanning-based spread. The delta per spread ratio is applicable, but, as will
be described
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below, its application is somewhat different for a scanning-based spread than
for a delta-
based spread.
[00336] One of the legs of a scanning-based spread is designated as the target
leg,
and there is an associated parameter of the target leg called the target leg
required flag:
= If the target leg required flag is true, then the combined commodity
designated as
the target leg must be present in the portfolio in order for the spread to be
formed,
and if it is not, the spread is skipped.
= If the target leg required flag is false, then the combined commodity
designated as
the target leg need not be present in the portfolio in order for the spread to
be
formed.
[00337] Similarly, for each leg which is not the target (a "non-target leg"),
there is a
parameter called the leg-required flag. If any non-target leg which is
specified as
required is not present in the portfolio, then the spread is skipped. In other
words, all
required non-target legs must be present in the portfolio in order for the
spread to be
formed.
[00338] As with a delta-based spread, a scanning-based spread has one or more
credit rates specified for it, for different account types and requirement
levels for those
account types.
[00339] All legs for a scanning-based spread must have the same scan point
definitions.
[00340] Evaluating a Scanning-Based Spread: Verify that all of the required
legs
are represented in the portfolio. Skip the spread if not.
=:e For the target leg:
- Aggregate from the target leg and each of the non-target legs, thereby
yielding the
new value for the target leg, each of the eight types of position value,
converted as
needed to the performance bond currency of the target leg.
= For each directly calculated requirement level:
- For each scanning tier for the target leg:
~ For the target leg and for each non-target leg:
= Perform the Risk Array Scaling and Currency Conversion Algorithm:
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= Take the risk array for the tier.
= For each value in the risk array:
- If this value is negative (i.e., a gain), multiply it by the credit rate
expressed as a decimal fraction.
- If this leg is not the target, and if the performance bond currency for
this leg is different from the performance bond currency for the
target leg, then convert the value to the performance bond currency
of the target.
~ Take the sum all of these appropriately scaled and converted risk arrays.
This
yields the new risk array for the overall scanning tier for the target leg.
~ Select the largest loss and determine the scan risk and active scenario,
exactly
as for any scanning tier.
~ For each non-target leg:
= Set each value in the risk array for the tier to zero.
= Then repeat the process of selecting the largest loss and determining the
scan risk, thereby setting these values to zero.
- For each delta period for the target leg:
~ For the corresponding delta period for each non-target leg that exists:
= Divide the delta-per-spread ratio for the target leg by the delta-per-spread
ratio for this non-target leg, yielding the aggregation ratio:
= Determine the remaining delta to be aggregated:
= Multiply the remaining delta for this delta period by the aggregation
ratio.
= Determine the original delta to be aggregated:
= Multiply the original delta for this delta period by the aggregation ratio.
~ Take the sum of the remaining delta to be aggregated values from the
corresponding delta period for each non-target leg that exists, and add this
result to the remaining delta for this delta period on the target leg,
yielding the
new value for remaining delta for the target leg.
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~ Take the sum of the original delta to be aggregated values from the
corresponding delta period for each non-target leg that exists, and add this
result to the original delta for this delta period on the target leg, yielding
the
new value for original delta for the target leg.
~ Take the sum of the Delivery (Spot) Charge for Delta Consumed by Spreads
from the corresponding delta period for each non-target leg that exists
(converted as needed to the performance bond currency of the target leg), and
add this result to the same value on the target leg, yielding the new value
for
Delivery (Spot) Charge for Delta Consumed by Spreads for this delta period
for the target leg.
~ Take the sum of the Delivery (Spot) Charge for Delta Remaining in Outrights
from the corresponding delta period for each non-target leg that exists
(converted as needed to the performance bond currency of the target leg), and
add this result to the same value on the target leg, yielding the new value
for
Delivery (Spot) Charge for Delta Remaining in Outrights for this delta period
for the target leg.
~ Set to zero for the corresponding delta period for each non-target leg:
= Original delta and remaining delta
= Delivery charge for delta consumed by spreads, and delivery charge for
delta remaining in outrights
- For each intercommodity spread tier for the target leg:
~ For the target leg and for each non-target leg:
= Perform the same Risk Array Scaling and Currency Conversion Algorithm
as described above for the scanning tiers
~ Take the sum all of these appropriately scaled and converted risk arrays.
This
yields the new risk array for the intercommodity spread tier for the target
leg.
~ Aggregate from the target leg and each non-target leg, thereby yielding the
new value for the target leg, each of the following elements:
= Intercommodity spread credit (converted as needed to the performance
bond currency of the target leg)
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= Inter-clearing organization spread credit (converted as needed to the
performance bond currency of the target leg)
~ Take the sum of the original delta for each delta period within this tier
which is
positive, yielding the new value for original long delta for the tier.
~ Take the sum of the remaining delta for each delta period within this tier
which
is positive, yielding the new value for remaining long delta for the tier.
~ Take the sum of the original delta for each delta period within this tier
which is
negative, yielding the new value for original short delta for the tier.
~ Take the sum of the remaining delta for each delta period within this tier
which
is negative, yielding the new value for remaining short delta for the tier.
~ Select the largest loss and determine the time risk, volatility risk, price
risk and
weighted price risk, exactly as for any intercommodity spreading tier.
~ For each intercommodity spread tier for each non-target leg:
= Set each value in the risk array for the tier to zero.
= Set the original delta and remaining delta values to zero.
= Set the intercommodity spread credit and inter-clearing organization spread
credit to zero.
= Repeat the process of determining the largest loss, volatility risk, time
risk,
price risk and weighted price risk, thereby setting all of these values to
zero.
- For each intracommodity spread tier for the target leg:
~ Take the sum of the original delta for each delta period within this tier
which is
positive, yielding the new value for original long delta for the tier.
~ Take the sum of the remaining delta for each delta period within this tier
which
is positive, yielding the new value for remaining long delta for the tier.
~ Take the sum of the original delta for each delta period within this tier
which is
negative, yielding the new value for original short delta for the tier.
~ Take the sum of the remaining delta for each delta period within this tier
which
is negative, yielding the new value for remaining short delta for the tier.
~ For each intracommodity spread tier for each non-target leg:
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= Set the original delta and remaining delta values to zero.
- For each short option minimum tier for the target leg:
~ Aggregate from the target leg and the equivalent tier on each non-target
leg,
thereby yielding the new for the target leg, each of the following elements:
= Number of short puts
= Number of short calls
= Short option minimum charge (converted as needed to the performance
bond currency for the target leg)
~ For each non-target leg:
= Set the number of short puts, the number of short calls, and the short
option
minimum charge, to zero.
- For the target leg combined commodity for this requirement level:
~ Aggregate from the target leg and each non-target leg, thereby yielding the
new value for the target leg:
= Intracommodity spread charge (converted as needed to the performance
bond currency of the target leg)
[00341] Hybrid Delta-Based / Scanning-Based Spreads: A hybrid delta-based /
scanning-based intercommodity spread combines elements of delta-based
spreading and
scanning-based spreading.
[00342] Hybrid spreads may be present only in the normal intercommodity spread
group, or the pre-crossmargining spread group.
[00343] Like a regular delta-based spread, the delta-based spread part of the
liybrid
spread definition will contain a collection of delta-based spread legs. There
are several
restrictions, however, on the specification of the spread and of its spread
legs:
= The spread is not recursive -- i.e., it may not contain a subsidiary
collection of
delta-based spreads.
= Each spread leg may reference onl.y the overall intercommodity spread tier
of a
specific combined commodity. References to specific intercommodity spread
tiers
or to delta periods are not allowed.
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= All of the combined commodities referenced as legs of the delta-based spread
must have the same performance bond currency.
= A charge rate must be specified for the delta-based spread, which rate is
denominated in that same performance bond currency.
[00344] Like a scanning-based spread, a llybrid spread will also specify a
target leg,
which will reference a specific combined commodity. This target combined
commodity
is never one into which any products are linked. It is not referenced by any
spread until
the hybrid spread for which it is specified as the target. After this spread,
it may
subsequently participate in intercommodity spreading, but only as a leg of a
regular delta-
based spread.
[00345] Here's the detailed algorithm for evaluating a hybrid spread:
= For each directly-calculated requirement level:
- Perform the Algorithm for evaluating a top-level delta-based spread as
described
above, with one exception as specified herein:
~ This has the effect of determining under each assumption of relative market-
side, the number of delta-based spreads formable, of calculating the
associated
charge, and of decreasing series and tier deltas for each leg according to the
delta consumed by the spread.
~ The exception is that the charge calculated under each assumption of
relative
market-side is not apportioned back to the legs of the spread. Instead, the
charges calculated under each assumption are summed to yield the basis risk.
- Take the sum of the scan risk values for each of the overall intercommodity
spread
tiers in the non-target legs participating in the spread, yielding the total
scan risk.
- Now perform the Algorithm for evaluating a scanning-based spread as
described
above, using a 100% credit rate, but with the following exceptions:
~ For each non-target leg, for the overall scanning tier, for any specific
scanning
tiers, for the overall intercommodity spreading tier, and for any specific
intercommodity spreading tiers, do not set each value in the risk array for
the
tier to zero, and do not then re-evaluate for the tier the scan risk and (for
the
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intercommodity spread tiers) the time risk, volatility risk, price risk and
weighted price risk.
~ Similarly, do not aggregate from the non-target legs to the target leg, and
then
set to zero on the non-target legs: the intracommodity spread charge
= for the overall intercommodity spread tier and for any specific
intercommodity spread tiers, the intercommodity spread credit and the
inter-clearing organization spread credit
= for each delta period, the charge for delta consumed by spreads and the
charge for delta remaining in outrights
= for the overall short option minimum rate tier and for any specific short
option minimum rate tiers, the short option minimum charge, and the
number of short puts and the number of short calls
~ For the target leg, after determining the weighted price risk:
= Save the value for the scan risk on the target leg as the scan together
risk.
= For the overall intercommodity spread tier, the overall scan tier, and any
specific intercommodity spread tiers and specific scanning tiers:
= set the scan risk value to zero
= for the intercommodity spread tiers, set the time risk, volatility risk, and
price risk to zero, leaving only the value for weighted price rislc.
~ The net result of this processing is that:
= Remaining deltas have been aggregated for intracommodity spread tiers,
intercommodity spread tiers, and delta periods, from the non-target legs to
the target.
= Weighted price risk has been determined for the overall intercommodity
spread tier on the target.
= All other elements of the SPAN risk calculation remain with the non-target
legs: the scan risk, intracommodity spread charge, short option minimum.,
spot charge, interconunodity spread credit, and inter-clearing organization
spread credit.
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= The value that would have been the scan risk for the target leg in a normal
scanning-based spread has been saved as the scan together risk.
- Take the sum of basis risk and scan together risk. Subtract this sum from
the total
scan risk. Divide this result by total scan risk. Take the larger of this
result, and
zero, thereby yielding the savings percentage.
- For the overall intercommodity spread tier for each non-target leg:
~ Take the largest loss for the tier.
~ Multiply by the savings percentage, yielding the credit for this leg for the
spread.
~ Round this result to the normal precision for values denominated in this
currency.
~ Increment the intercommodity spread credit for the tier, by this amount.
~ Again take the largest loss for the tier. Divide this value by the scan
together
risk. Save this result as the scan risk percentage for subsequent use.
[00346] Execution now proceeds to the next spread definition in the spread
group,
and to the remaining spread groups to be evaluated.
[00347] As it does, the overall intercommodity spread tier of the combined
commodity, which was the target of the original hybrid spread, may participate
as a leg of
other delta-based interconimodity spreads using the weighted price risk method
of
determining the credit.
[00348] If this occurs, the intercommodity spread credit for the original
target leg
calculated as a result of that delta-based spread, is apportioned back to the
original non-
target legs of the original hybrid spread, in proportion to the scan risk for
that leg to the
total scan risk. Here's how:
= For each directly-calculated requirement level for the original hybrid
spread target
leg:
- Take the intercommodity spread credit value just calculated.
- For each original non-target leg for the original hybrid spread:
~ Multiply the above value by the scan risk percentage for that non-target
leg.
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~ Round this result to the normal precision for the performance bond currency
for that non-target leg.
~ Increment the intercomtnodity spread credit (or the inter-clearing
organization
spread credit if the spread now being processed is within the inter-clearing
organization spread group or the cross-margin spread group) by this result.
- Set the intercommodity spread value for the original hybrid spread target
leg back
to zero.
[00349] Finalizing the Spot Charge: This calculation will be performed for
each
combined commodity, after all spreads in the intracommodity spread group have
been
evaluated, but before any of the subsequent spread groups have been processed.
= For each combined commodity in the portfolio:
- For each directly calculated requirement level for this combined commodity:
~ For each delta period for this combined commodity to which spot charges
apply:
= If for this delta period it has been specified that spot charges apply to
either
long or short delta, OR if it has been specified that they apply to long delta
only and the remaining delta for the period is positive, OR if it has been
specified that they apply to short delta only and the remaining delta for the
period is negative:
= Subtract the remaining delta for this period and requirement level from
the original value for delta for the period and this requirement level.
Take the absolute value of this amount. This yields the delta consumed
by spreads.
= Take the absolute value of the remaining delta for this period. This
yields the delta remaining in outrights.
= Multiply the delta consumed by spreads, by the charge rate for delta
consumed by spreads, yielding the spot charge for delta consumed by
spreads for this period and requireinent level.
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= Multiply the delta remaining in outrights, by the charge rate for delta
remaining in outrights, yielding the spot charge for delta remaining in
outrights for this period and requirement level.
= Otherwise, the values for these two charges are zero.
~ Sum the spot charge for delta consumed by spreads for each period, yielding
the total spot charge for delta consumed by spreads for this combined
commodity for this requirement level.
~ Sum the spot charge for delta remaining in outrights for each period,
yielding
the total spot charge for delta remaining in outrights for this combined
commodity for this requirement level.
~ Sum the spot charge for delta consumed by spreads, and the spot charge for
delta remaining in outrights, yielding the total spot charge for the combined
commodity and this requirement level.
[00350] Finalizing the Intercommodity Spread Credit and the Interexchange
Spread
Credit: For each combined commodity in the portfolio:
- For each directly calculated requirement level for the combined commodity:
~ Take the sum of the intercommodity spread credit for the overall
intercommodity spread tier, and the intercommodity spread credits for each
specific intercommodity spread tier, if any. This yields the total
intercommodity spread credit for the combined commodity.
~ Take the sum of the inter-clearing organization spread credit for the
overall
intercommodity spread tier, and the inter-clearing organization spread credits
for each specific intercommodity spread tier, if any. This yields the total
inter-
clearing organization spread credit for the combined commodity.
[00351] Finalizing the SPAN Requirement(s) for Directly Calculated Requirement
Levels: For each combined commodity in the portfolio:
- For each directly calculated requirement level for the combined commodity:
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~ Take the sum of the scan risk, the intracommodity charge, and the spot
charge.
(This value is sometimes called the commodity risk.)
~ Subtract from this value, the sum of the intercommodity spread credit and
the
inter-clearing organization spread credit. (This value is sometimes called the
prototype SPAN risk, or the pre-SPAN risk.)
~ Take the larger of this value and the short option minimum.
~ If a risk adjustment factor is defuied for this directly calculated
requirement
level, multiply the above result by this risk adjustment factor.
~ If the positions in this combined commodity consist solely of long positions
in
option products, all of which options have non-zero values for their prices,
then take the smaller of this result and the current value of those options in
the
performance bond currency.
~ The result is the SPAN risk requirement for this requirement level.
[00352] The third to last step is called capping the risk at long option value
for
portfolios consisting solely of long options. Note that the value at which the
risk is
capped may include both fiitures-style options and premium-style options. The
key factor
here is not how the options are valued, but whether they are long positions in
products for
which the current value of the risk is limited to the current value of the
positions
themselves.
[00353] Determining Derived SPAN risk requirements: For each combined
commodity represented in the portfolio:
- For each directly calculated requirement level for this combined commodity:
~ For each risk adjustment factor applicable to that requirement level or to
any
requirement level derived from that requirement level:
= Process each such risk adjustment factor in turn:
= Take the SPAN risk requirement for the base requirement level.
= Multiply by the risk adjustment factor, which converts a requirement
from the specified base requirement level to the specified derived
requirement level.
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= If the positions in this combined commodity consist solely of long
positions in option products, all of which options have non-zero values
for their prices, then take the smaller of this result and the current value
of those options in the performance bond currency.
= The result is the SPAN risk requirement for the derived requirement
level.
[00354] Typically risk adjustment factors used to determine derived
requirements,
are used to determine an initial requirement level from a maintenance
requirement level.
[00355] Determining the Available Net Option Value: For each combined
commodity in the portfolio:
- Determine the total net value in the performance bond currency of all
positions in
the portfolio for this combined commodity which are valued premium-style, as
follows:
~ Take the following four values denominated in the performance bond
currency:
= value of long option positions in products valued premium-style
= value of short option positions in products valued premium-style
= value of long non-option positions in products valued premium-style
= value of short non-option positions in products valued premium-style
~ If there are any portion of these position values for which full credit is
not
being given due the premium not yet having been paid or collected, adjust
these values accordingly to remove that portion.
~ Subtract the adjusted value of short option positions valued premium-style
from the adjusted value of long option positions valued premium-style,
yielding the net value of option positions valued premium-style.
~ Subtract the adjusted value of short non-option positions valued premium-
style
from the adjusted value of long non-option positions valued premium-style,
yielding the net value of non-option positions valued premium-style.
~ Take the sum of these two net values, yielding the net adjusted value of
positions valued premium-style.
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- For each requirement level for this combined commodity (whether directly
calculated or derived):
~ If for this combined commodity capping off available net option value at the
risk has been enabled, then take the smaller of the net adjusted value of
positions valued premium-style, and the SPAN risk requirement, yielding the
available net option value for this requirement level.
~ But if such capping has not been enabled, the available net option value for
this requirement level is equal to the net adjusted value of positions valued
premium-style.
[00356] The SPAN calculation for omnibus accounts and other gross-inargined
firm-level accounts: As described above in the introductory section,
Portfolios to be
margined, an omnibus account is:
= a firm-level account type
= for which total positions are maintained on a gross basis -- i.e., they may
be
simultaneously long and short
= for which subaccounts may be defmed
= for which the portion of the total long and total short positions which are
not
contained in said defmed subaccounts, are considered to be the naked long and
naked short positions
= for which the naked long and naked short positions are margined on a gross
basis -
- in other words, treated as if each such naked long position and each such
naked
short position is in a portfolio by itself, without any risk reductions due to
offsetting positions.
[00357] Generically, a gross-margined firm-level account is any such account
for
which naked long and nalced short positions are margined in this manner. An
omnibus
account may be considered to be an example of such an account for which there
may also
be positions in defined subaccounts.
[00358] This section describes the overall process for determining the SPAN
risk
requirements and the Available Net Option Values for the combined commodities
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represented in the portfolio for gross-margined firm-level accounts. This
process consists
of:
= Determining the naked long and naked short positions
= Calculating SPAN requirements for the subaccounts, if any
= Calculating SPAN requirements for the naked positions
= Aggregating SPAN requirements for the subaccounts with the SPAN requirements
for the naked positions, in order to determine the total SPAN requirement
values
for the combined commodity.
[003591 Determining the Naked Positions: For each position in the omnibus
account:
- Take the sum of all subaccount positions in this product that are net long.
- Subtract this result from the Total Long position quantity for the omnibus
account,
yielding the Naked Long position.
- Take the absolute value of the sum of all subaccount positions in this
product that
are net short.
- Subtract this result from the Total Short position quantity for the omnibus
account,
yielding the Naked Short position.
[00360] Note that for each product represented in the omnibus account
portfolio,
the Total Long position must be at least as great as the sum of the subaccount
positions
that are net long, and the Total Short position must be at least as great as
the absolute
value of the sum of the subaccount positions that are net short. Naked
position quantities
may be zero, but by definition they may never be negative.
[00361] Calculating SPAN requirements for subaccounts: Whenever the SPAN
calculation is to be performed for an omnibus account, after determining the
naked
positions, the normal SPAN calculation for net portfolios should be performed
for each
subaccount of that omnibus account, if any are defmed.
[00362] For each such subaccount, for each combined commodity represented in
the portfolio for the subaccount, the result will be the SPAN risk requirement
and
Available Net Option Value for each directly-calculated and indirectly-
calculated
requirement level for that combined commodity.
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[00363] Evaluating the SPAN requirements for the subaccounts first simplifies
the
SPAN calculation for the omnibus account, in that it ensures that the
subaccount
requirements will be available for aggregation to the omnibus account when
they are
needed.
[00364] Calculating SPAN requirements for naked positions: For each combined
commodity in the portfolio:
- For each position for this combined commodity:
~ For the naked long position quantity, perform the Naked Position SPAN
evaluation algorithm to determine for each directly and indirectly calculated
requirement level for this combined commodity:
= the SPAN risk requirement
= the Available Net Option Value
~ For the naked short position quantity, perform the Naked Position SPAN
evaluation algorithm to determine for each directly and indirectly calculated
requirement level for this conibin.ed commodity:
= the SPAN risk requirement
= the Available Net Option Value
~ For each directly and indirectly calculated requirement level for this
combined
commodity:
= Sum the SPAN requirement for naked longs for this requirement level, and
the SPAN requirement for naked shorts for this requirement level, yielding
the total SPAN requirement for nakeds for this position and this
requirement level.
= Sum the Available Net Option Value for naked longs for this requirement
level, and the Available Net Option Value for naked shorts for this
requirement level, yielding the total Available Net Option Value for nakeds
for this position and this requirement level.
- For each directly and indirectly calculated requirement level:
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~ Take the sum of the SPAN requirement for nakeds, across all positions for
the
combined commodity, yielding the SPAN requirement for naked positions for
the combined commodity for this requirement level.
~ Take the sum of the Available Net Option Value for nakeds, across all
positions for the combined commodity, yielding the Available Net Option
Value for naked positions for the combined commodity for this requirement
level.
[00365] Naked Position SPAN Evaluation Algorithm: As described above, this
algorithm is described to either the naked long quantity or the naked short
quantity of a
position held in a gross-margined account, either at the firm.-level or the
clearing-level.
= Create a net portfolio for the purpose of this calculation, consisting
solely of this
naked long (or naked short) position.
= Apply the SPAN algorithm to this net portfolio.
= For each requirement level directly calculated:
- Determine the SPAN requirement and the Available Net Option Value for this
requirement level and for the combined commodity containing the net position.
- If split allocation or margining-positions-as-equivalents caused other
combined
commodities to be represented in the portfolio:
~ For each such other combined commodity, determine the value of the SPAN
requirement and the Available Net Option Value for that other combined
commodity, in the performance bond currency of the original combined
commodity containing the position:
= If the performance bond currency of this other combined commodity is the
same as the performance bond currency of the combined commodity
containing the positions, simply take the SPAN requirement and the
Available Net Option Value for that other combined commodity.
= But if these two currencies are not the same:
= Multiply the SPAN requirement for the other combined commodity by
the appropriate rate to convert it to the performance bond currency of
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the original combined commodity, and round this result to the normal
precision for that original performance bond currency.
= Multiply the Available Net Option Value for the other combined
conunodity by the same rate, and round this result to the normal
precision for that original performance bond currency.
~ Take the sum of these equivalent values for SPAN requirement, across all
such
other combined commodities.
~ Increment the SPAN requirement for the original combined commodity
containing the net position, by this sum.
~ Take the sum of the equivalent values for Available Net Option Value, across
all such other combined cozrunodities.
~ Increment the SPAN requirement for the original combined commodity
containing the net position, by this sum.
- The result so far is the SPAN requirement and the Available Net Option Value
for
the naked long (or naked short) position for this directly calculated
requirement
level.
- If any requirement levels are derived from this directly calculated
requirement
level, apply the risk adjustment factor(s) in turn to determine the derived
SPAN
risk requirement and Available Net Option Value for the naked long (or naked
short) position for each such derived requirement.
[00366] Aggregating SPAN requirements for Naked Positions with SPAN
requirements for subaccounts: For each combined commodity represented in the
omnibus
account portfolio:
- For each requirement level for which requirements have been determined for
this
portfolio, whether directly or indirectly calculated:
~ Take the sum of the SPAN risk requirements for this requirement level across
all subaccount portfolios in which this combined commodity is represented.
This yields the total SPAN risk requirement for subaccounts for this
requirement level.
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~ Similarly, take the sum of the Available Net Option Values for this
requirement level across all subaccount portfolios in which this combined
commodity is represented. This yields the total Available Net Option Value
for subaccounts for this requirement level.
~ Take the sum of the total SPAN risk requirement for subaccounts, and the
total
SPAN risk requirements for naked positions, yielding the overall SPAN risk
requirement for the combined commodity and this requirement level.
~ Similarly, take the sum of the total Available Net Option Value for
subaccounts, and the total Available Net Option Value for naked positions,
yielding the overall Available Net Option Value for the combined commodity
and this requirement level.
[00367] The SPAN Calculation for Gross-Margined Clearing-Level Accounts:
Specification of gross clearing-level positions
[00368] As described above in the introductory section Portfolios to be
margined,
when a clearing-level account is said to be gross-margined, this means the
following.
[00369] First, positions are maintained on a gross basis. For any particular
position
in the portfolio, a Total Long position and a Total Short position are defmed.
[00370] Second, of the Total Long and Total Short position quantities, some
portion
is specified to be intercommodity spreadable and some portion is said to be
intracommodity spreadable. Positions that are neither inter nor intracommodity
spreadable are naked.
[00371] So for each position in a gross-margined clearing-level portfolio, six
position quantity values will be specified:
= Total Long
= Total Short
= Intracommodity Spreadable Long
= Intracommodity Spreadable Short
= Intercommodity Spreadable Long
= Intercommodity Spreadable Short
= Naked Long
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= Naked Short
[00372] Note that we are following the same convention as with gross-margined
firm-level accounts, where both long and short position quantities are
expressed as
positive numbers.
[00373] At the CME, when clearing member firtns report their positions for a
processing cycle, they specify for each position the total long and short
quantities, the
intracommodity spreadable long and short quantities, and the intercoinmodity
spreadable
long and short quantities.
[00374] The naked long quantity is then determined by subtracting the
intracommodity spreadable long quantity and the intercommodity spreadable long
quantity from the total long quantity, and analogously for the naked short
quantity.
[00375] By definition, the total long quantity must always be the sum of the
intracommodity spreadable long, the intercommodity spreadable long, and the
nalced
long. The total short must always be the sum of the intracommodity spreadable
short, the
intercommodity spreadable short, and the naked short.
[00376] Overall SPAN process for gross-margined clearing-level portfolios: For
each position in the portfolio:
- Determine the intracommodity spreadable net position quantity by subtracting
the
intracommodity spreadable short quantity from the intracommodity spreadable
long quantity.
- Determine the intercommodity spreadable net position quantity by subtracting
the
intercommodity spreadable short quantity from the intercommodity spreadable
long quantity.
=ee Process the portfolio of intercommodity spreadable net positions through
the SPAN
algorithm as described above for net portfolios. This yields, for each
combined
commodity in the portfolio, for each directly and indirectly-calculated
requirement
level for that combined commodity, the SPAN requirement and the Available Net
Option Value for the intercommodity spreadable positions.
~.= Process the portfolio of intracommodity spreadable net positions through
SPAN
algorithm as described above for net portfolios, but omit processing of all of
the
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spread groups except the intracommodity spread group. The result is, for each
combined coinmodity in the portfolio, for each directly and indirectly-
calculated
requirement level for that combined commodity, the SPAN requirement and the
Available Net Option Value for the intracommodity spreadable positions.
= Process each naked long and naked short position through the SPAN algorithm
for
naked positions, and aggregate the resulting naked risk requirements and
available net
option values to the combined commodity level, exactly as described above for
omnibus accounts. The result is, for each combined commodity in the portfolio,
for
each directly and indirectly calculated requirement level for that combined
commodity, the SPAN requirement and the Available Net Option Value for naked
positions.
=Z= For each combined commodity in the portfolio:
- For each directly and indirectly calculated requirement level for the
combined
commodity:
~ Take the sum of the SPAN risk requirement for intercommodity spreadable
positions, the SPAN risk requirement for intracommodity spreadable positions,
and the SPAN risk requirement for naked positions. The result is the total
SPAN risk requirement for the combined commodity for this requirement
level.
~ Take the sum of the Available Net Option Value for intercommodity
spreadable positions, the Available Net Option Value for intracommodity
spreadable positions, and the Available Net Option Value for naked positions.
The result is the total Available Net Option Value for the combined
commodity for this requirement level.
[00377] Aggregation of Values from Combined Commodities: Determining values
to use for aggregation for each combined commodity
= Determine the highest performance bond class for which requirement have been
calculated ainong all combined commodities represented within the portfolio.
= For each combined commodity in the portfolio:
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- For each such perforinance bond class for which requirements have been
calculated, beginning with the core class and ascending in priority order to
the
highest class represented in the portfolio:
~ If requirements were calculated for this class:
= Use the calculated values for the following four values, as the values to
use
for aggregation:
= SPAN requirement - maintenance - specified class
= SPAN requirement - initial - specified class
= Available Net Option Value - maintenance - specified class
= Available Net Option Value - initial - specified class
~ But if requirements were not calculated for this class for this combined
commodity:
= Use the above four values for aggregation for the immediately preceding
class, as the values for aggregation for this class.
[0037$] Aggregation of currency-level requirements from combined commodities
to report groups, exchange complexes, and the overall portfolio level:
e~e For each exchange complex represented in the portfolio:
- For each combined commodity report group for this exchange complex:
~ Determine the set of performance bond currencies represented among the
combined commodities for this report group within this exchange complex.
~ For each such performance bond currency represented within the group:
= For each perfornlance bond class for which requirements have been
calculated within the portfolio:
= Take the sum of the values for aggregation, for this class, for any
combined commodity within the group with this performance bond
currency, of the following:
- SPAN requirement - maintenance - specified class
- SPAN requirement - initial - specified class
- Available Net Option Value - maintenance - specified class
- Available Net Option Value - initial - specified class
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= The result is the specified value, for the specified class, for the
specified
performance bond currency, for the specified report group with the
specified exchange complex.
+:= For each exchange complex represented in the portfolio:
- Determine the set of performance bond currencies represented among the
combined commodities within this exchange complex.
- For each such performance bond currency represented within the exchange
complex:
~ For each performance bond class for which requirements have been calculated
within the portfolio:
= Take the sum of the values for aggregation, for this class, for any combined
commodity within the exchange complex with this performance bond
currency, of the following:
= SPAN requirement - maintenance - specified class
= SPAN requirement - initial - specified class
= Available Net Option Value - maintenance - specified class
= Available Net Option Value - initial - specified class
= The result is the specified value, for the specified class, for the
specified
performance bond currency, for the specified exchange complex.
e.= For the total portfolio:
- Determine the set of performance bond currencies represented among the
combined cominodities within the total portfolio.
- For each such performance bond currency represented:
~ For each performance bond class for which requirements have been calculated
within the portfolio:
= Take the sum of the values for aggregation, for this class, for any combined
commodity within the portfolio, of the following:
= SPAN requirement - maintenance - specified class
= SPAN requirement - initial - specified class
= Available Net Option Value - maintenance - specified class
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= Available Net Option Value - initial - specified class
= The result is the specified value, for the specified class, for the
specified
performance bond currency, for the total portfolio.
[00379] Determining Portfolio-Currency Equivalent Requirement Values: For each
exchange complex within the portfolio:
- For each report group within that exchange complex:
~ For each performance bond class for which requirements have been calculated
within the portfolio:
= For each performance bond currency represented within that report group:
= Determine the portfolio-currency equivalents as specified below, of the
following four values:
- SPAN requirement - maintenance - specified class
- SPAN requirement - initial - specified class
- Available Net Option Value - maintenance - specified class
- Available Net Option Value - initial - specified class
- If the portfolio currency is equal to this performance bond currency,
then the portfolio currency value is the specified value.
- But if the portfolio currency is different from this performance bond
currency, determine the portfolio currency equivalent value:
~ Multiply the value in the performance bond currency by the
appropriate conversion rate. Then round to the normal precision
for this portfolio currency.
= Take the sum of the portfolio-currency equivalent value for the
maintenance SPAN requirement for this class for the different
performance bond currencies, yielding the total portfolio-currency
equivalent value for the maintenance SPAN requirement for this class
and this report group.
= Take the sum of the portfolio-currency equivalent value for the initial
SPAN requirement for this class for the different performance bond
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currencies, yielding the total portfolio-currency equivalent value for the
initial SPAN requirement for this class and this report group.
= Take the sum of the portfolio-currency equivalent value for the
maintenance Available Net Option Value for this class for the different
performance bond currencies, yielding the total portfolio-currency
equivalent value for the maintenance Available Net Option Value for
this class and this report group.
= Take the sum of the portfolio-currency equivalent value for the initial
Available Net Option Value for this class for the different performance
bond currencies, yielding the total portfolio-currency equivalent value
for the initial Available Net Option Value for this class and this report
group.
=3 For each exchange complex within the portfolio:
- For each performance bond class for which requirements have been calculated
for
this exchange complex within the portfolio:
~ For each performance bond currency represented within that exchange
complex:
= Determine the portfolio-currency equivalents as specified below, of the
following four values, exactly as this was done above:
= SPAN requirement - maintenance - specified class
= SPAN requirement - initial - specified class
! Available Net Option Value - maintenance - specified class
= Available Net Option Value - initial - specified class
= Take the sum of the portfolio-currency equivalent value for the
maintenance SPAN requirement for this class for the different performance
bond currencies, yielding the total portfolio-currency equivalent value for
the maintenance SPAN requirement for this class and this exchange
complex.
= Take the sum of the portfolio-currency equivalent value for the initial
SPAN requirement for this class for the different performance bond
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currencies, yielding the total portfolio-currency equivalent value for the
initial SPAN requirement for this class and this exchange complex.
= Take the sum of the portfolio-currency equivalent value for the
maintenance Available Net Option Value for this class for the different
performance bond currencies, yielding the total portfolio-currency
equivalent value for the maintenance Available Net Option Value for this
class and this exchange complex.
= Take the sum of the portfolio-currency equivalent value for the initial
Available Net Option Value for this class for the different performance
bond currencies, yielding the total portfolio-currency equivalent value for
the initial Available Net Option Value for this class and this exchange
complex.
:e For the total portfolio:
- For each performance bond class for which requirements have been calculated
within the portfolio:
~ For each performance bond currency represented within the total portfolio:
= Determine the portfolio-currency equivalents as specified below, of the
following four values, exactly as this was done above:
= SPAN requirement - maintenance - specified class
= SPAN requirement - initial - specified class
= Available Net Option Value - maintenance - specified class
= Available Net Option Value - initial - specified class
= Take the sum of the portfolio-currency equivalent value for the
maintenance SPAN requirement for this class for the different performance
bond currencies, yielding the total portfolio-currency equivalent value for
the maintenance SPAN requirement for this class and the total portfolio.
= Take the sum of the portfolio-currency equivalent value for the initial
SPAN requirement for this class for the different performance bond
currencies, yielding the total portfolio-currency equivalent value for the
initial SPAN requirement for this class and the total portfolio.
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= Take the sum of the portfolio-currency equivalent value for the
maintenance Available Net Option Value for this class for the different
performance bond currencies, yielding the total portfolio-currency
equivalent value for the maintenance Available Net Option Value for this
class and the total portfolio.
= Take the sum of the portfolio-currency equivalent value for the initial
Available Net Option Value for this class for the different performance
bond currencies, yielding the total portfolio-currency equivalent value for
the initial Available Net Option Value for this class and the total portfolio.
[00380] Comparison of collateral to requirements and determination of whether
an
excess or a deficiency exists: The SPAN algorithm determines the SPAN
requirements
and available net option value for the different requirement levels for each
combined
commodity within the portfolio, and aggregates of these values to the report
group,
exchange complex and total portfolio levels, both by performance bond currency
represented and as equivalent values in the portfolio currency.
[00381] The valuation of collateral deposited to meet requirements, the
comparison
of collateral to requirements and the determination of excess or deficit
amounts is, strictly
speaking, outside the scope of SPAN. At the clearing-level, and especially if
requirements are calculated for more than one performance bond class and if
various
different types of collateral are accepted, this process can be complex.
[00382] For ordinary customer accounts at the firm-level, where only one class
of
performance bond requirement is calculated, the process is typically much
simpler, and is
described herein.
= Determine the overall value in the portfolio currency to be used for
margining (the
"performance bond" value) of non-cash collateral assets. This value is
typically called
the securities on deposit.
= Determine the net value in the portfolio currency of cash in the account due
to gains
(or losses) on open positions in products valued futures-style. This value is
typically
called the open trade equity.
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= Determine the net value in the portfolio currency of all other cash in the
account. This
value is typically called the ledger balance.
= Take the.sum of the above three values, plus the available net option value
for the
maintenance requirement for the core performance bond class. This yields the
funds
available for margin for the core maintenance requirement.
= Take the sum of the above three values, plus the available net option value
for the
initial requirement for the core class. This yields the funds available for
margin for
the core initial requirement.
= Determine whether the portfolio is considered "new" or "existing":
- If the portfolio contained no positions whatever at the close of business
for the
preceding business day, then portfolio is considered to be a new one.
- Otherwise, the portfolio is considered to be a previously existing one.
= If the portfolio is considered "existing" and If the funds available for
margin for the
maintenance requirement for the core class, is greater than or equal to the
core
maintenance SPAN requireinent:
- Then the maintenance requirement is deemed to be applicable. The applicable
SPAN risk requirement is the SPAN requirement for maintenance for the core
class, and the applicable funds available for margin is equal to the funds
available
for margin for maintenance for the core class.
= But if the portfolio is considered "new" or if it is considered existing,
but the funds
available for margin for the maintenance requirement for the core class is
less than the
SPAN requirement for maintenance for the core class:
- Then the initial requirement is deemed to be applicable. The applicable SPAN
risk requirement is the SPAN requirement for initial for the core class, and
the
applicable funds available for margin is the funds available for margin for
initial
for the core class.
= Subtract the applicable SPAN requirement from the applicable funds available
for
margin, yielding the excess (if this value is positive) or deficit (if this
value is
negative) amount.
[00383] Note that in most cases for customer account types other than
speculators,
and in some cases for speculators, the initial requirement is equal to the
maintenance
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requirement, and accordingly the initial funds available for margin is equal
to the
maintenance funds available for margin. The logic described above simplifies
substantially in this case.
[00384] Even in cases where initial requirements are different from
maintenance
requirements, funds available for margin for initial is typically equal to
funds available
for margin for maintenance. These two values could only be different if
coinbined
commodities are represented within the portfolio for which the available net
option value
is capped at the risk.
[00385] The disclosed system and method relates to Risk Management, i.e. the
determination of performance bonds as described above, as applied to fixed
payoff
products, i.e. contracts which payoff a fixed amount based on the outcome of
an
underlying event regardless of the particular value of the underlying event.
For example,
a particular contract may pay a set amount if the value of the underlying
instrument
equals a prescribed value, referred to as the "strike value;" if the value of
the underlying
instrument is above or below the strike value; if the value of the underlying
instrument
falls within a specified range of values; or combinations thereof Exemplary
fixed payoff
contracts are "binary options," "binders," "all or nothing," etc.
[00386] Binary options are options with binary or discontinuous payoffs. For
example, a cash-or- nothing call (put), pays off a fixed cash amount if the
underlying
asset price is above (below) a fixed level and otherwise has a zero payoff.
Asset-or-
notliing calls (puts) deliver the underlying asset (or its cash value) on the
expiration date
if the underlying asset price is above (below) a fixed level and otherwise has
a zero
payoff. Binary options are also known as "digital options" or "bet options".
Cash-or-
nothing options and asset-or-nothing options are also known as "all-or-nothing
options."
Each can be European or American and can be structured as a put or call.
[00387] A European cash-or-nothing binary pays a fixed amount of money if it
expires in the money and nothing otherwise. For exainple, a European cash-or-
nothing
call makes a fixed payment if the option expires with the underlier above the
strike price.
It pays nothing if it expires with the underlier equal to or less than the
strike price.
[00388] With cash settlement, the underlier is not physically delivered.
Instead, the
derivative settles for an amount of money equal to what the derivative market
value
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would be at maturity/expiration if it were a physically settled derivative. In
the case of a
forward, this equals the difference between the market value of the underlier
at maturity
and the contractual forward price. In the case of an option, it is the
intrinsic value.
[00389] An American cash-or-nothing binary is issued out-of-the-money and
makes
a fixed payment if the underlier value ever reaches the strike. The payment
can be made
immediately or deferred until the option's expiration date.
[003901 A European asset-or-nothing binary pays the value of the underlier (at
expiration) if it expires in the money. It pays nothing otherwise. For
example, a
European asset-or- nothing call pays the value of the underlier at expiration
if it exceeds
the strike price. A European asset-or-nothing put pays the value of the
underlier at
expiration if it is less than the strike price.
[00391] An asset-or-nothing binary might be structured as an American option
with
deferred payment, but this structure is not common.
[00392] Issuers of asset-or-nothing options can construct the instruments by
combining a cash- or-nothing binary with a vanilla put or call. A cash-or-
nothing binary
can be dynamically hedged but issuers sometimes hedge with a call spread
instead. Either
approach becomes problematic if the binary is at-the-money as it approaches
expiration.
[00393] In typical risk management systems, the margin required for a fixed
payoff
product is the price of the product, i.e. the trader must put up the entire
price of the
contract to cover the potential loss. Once the underlying event occurs and the
payoff of
the contract is known, the contract price, plus any earnings per the contract
are
distributed, i.e. profits are returned if the event was favorable, otherwise
the margin
requirement covers the loss. While this may be adequate for low price
contracts, this
system quickly becomes burdensome for high price contracts and limits the
flexibility of
traders to maintain large portfolios. This, in turn, limits market
efficiencies and results in
a sub-optimal market environment. As a trader includes more contracts and/or
higher
price contracts in their portfolio, they must pay a margin equal to the
contract price for
each, resulting in a significant amount of money being required up front.
Typically, this
has limited the price of fixed payoff products and discouraged traders from
maintaining
large portfolios, with many open positions at any given time.
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[00394] In particular, current risk management systems fail to compute an
overall
margin requirement based on the entirety of the portfolio of fixed payoff
products. These
systems, for example, do not account for offsetting within a given portfolio,
i.e. where the
portfolio contains multiple positions on the same underlying event, thereby
reducing the
loss potential. Further, current risk management systems fail to account for
the
probability of a given event resulting in a particular result, and crediting
the trader when
the probability of loss is low.
[00395] This is because the payoff structure of a given contract is not
smooth, i.e.
discontinuous, as noted above, and the losses may vary greatly from one strike
to the
next. Accordingly, traditional risk management methods do not work because
they
depend on unaccounted for or unknown scenarios resulting in only marginal
differences
between the predicted and actual losses, thereby minimizing the risk on the
parties. In
contrast, the difference in potential losses between scenarios of a fixed
price contract may
be significant wherein failure to account for a particular scenario may result
in significant
exposure of the parties. Accordingly, the prior systems take no chances and
require full
contract value, i.e. the highest potential loss, as the margin requirement.
[00396] Effectively, in these prior systems, the exchange bears no risk/burden
since
all contracts are fully margined, thereby putting all of the risk/burden on
the traders. By
bearing a portion of the risk/burden, an exchange, using the disclosed risk
management
system, may incentivize increased trading activity and increased per-contract
trade values,
thereby increasing market efficiencies, economic value and earnings for the
exchange.
[00397] The disclosed embodiments are capable of computing margin requirements
for products whose payoff may vary from day to day as well as, in conjunction
with the
above disclosed systems, products with known payoffs. The disclosed
embodiments are
also capable of working with products that may have several outcomes, of which
one is
the basis of a given contract. For example, the Federal Reserve interest rate
may be any
value but it will settle on only one value each day.
[00398] The disclosed embodiments calculate the worst possible outcome of the
overall portfolio, which may contain more than one instrument. This permits
the
portfolio to have both long and short positions on the same underlying event
and offsets,
e.g. combinations of long (bought but not closed out) and short (sold but not
closed out)
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positions, among instruments in the portfolio are factored in. A universe of
outcomes is
constructed including single events with single outcomes, and the probability
thereof, and
single events with inultiple outcomes, each with a probability thereof. In one
embodiment, this universe is implemented as a matrix probabilities on
different
outcomes, also referred to as "strikes." Each strike/outcome then has an
associated price
and probability, typically factored together as a single value reflective of
both. Events
with low probability will have low values, resulting in a lower margin
requirement, as
will be explained below.
[00399] In one embodiment, for portfolios of such products, the margin
requirement/performance bond is set equal to the amount of the maximum loss
that the
portfolio can sustain for any possible outcome of the underlying event,
adjusted for the
probability of the outcome.
[00400] Given the finite number of strike values for a given fixed payoff
contract, it
is not necessary to check every possible outcome. Accordingly, the disclosed
system and
method only checks outcomes at every strike value for which a given contract
can settle,
or at every strike value, plus an in between strike value, for contracts which
may settle
between strike values. Each of the possible outcomes is then assigned a
probability
weight to prevent the collection of excessively high performance bonds from
portfolios
where losses are highly unlikely.
[00401] The algorithm for the performance bond computation is thus:
1. Define a universe of outcomes to check as follows:
a. For products which can only settle at strike level,
the outcomes are all defined strikes
b. For products that can settle between strikes,
the universe of outcomes includes all strikes plus:
i. Point one tick below lowest strike
ii. Point one tick above highest strike
iii. One point in between each close pair of strikes
2. For each contract, calculate a risk array with number of points
equal to the number of outcomes defined at step 1 with each point
corresponding to the profit/loss for particular outcome adjusted
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for probability and interest rate.
Risk array points are defmed as follows:
a. For products which can only settle at strike level, risk array
points are every strike from lowest to highest
b. For products that can settle between strikes, iterate through
strikes starting with the lowest one adding following points
to risk array:
i. Point one tick below lowest strike
ii. Each strike
iii. Point one tick above each strike (if it is not equal to
the next strike)
For each contract, calculate risk array values for each risk array
Point as follows:
(Contract Value - Contract Payoff at this point discounted at
appropriate interest rate) * Probability weight
[00402] The probability weights are determined as follows:
Weight is equal to 1 for all outcomes where it is desirable not to give any
discount due to low probability and less than 1 for other outcomes. There are
two
possible methods of maintaining probability weights:
1. Provide weights separately for every risk array point as part
of risk array point definitions. This is the most flexible way, but would
require a lot of
maintenance especially in cases when new strikes could be added on the fly
thus changing
number of risk array points and requiring constant maintenance; or
2. Provide weights in "tiers" or for ranges of outcomes. For
example all outcomes between 100 and 200 would have a weight of 1 and from 200
and
higher - a weight of 0.9. This way requires less maintenance, but is a little
bit less
flexible.
[00403] Figure 1 shows an exemplary risk management system 100 according to
one embodiment. Herein, the phrase "coupled with" is defined to mean directly
connected to or indirectly connected through one or more intermediate
components. Such
intermediate components may include both hardware and software based
components.
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Further, to clarify the use in the pending claims and to hereby provide notice
to the
public, the phrases "at least one of <A>, <B>, ... and <N>" or "at least one
of <A>, <B>,
... <N>, or combinations thereof' are defined by the Applicant in the broadest
sense,
superceding any other implied definitions herebefore or hereinafter unless
expressly
asserted by the Applicant to the contrary, to mean one or more elements
selected from the
group comprising A, B, ... and N, that is to say, any combination of one or
more of the
elements A, B, ... or N including any one element alone or in combination with
one or
more of the other elements which may also include, in combination, additional
elements
not listed.
[00404] The exemplary risk management system 100 includes a risk analysis
engine
102. The risk analysis engine 102 receives a portfolio 104 to be analyzed and
a set of
parameters 108 which control the analysis. The engine 102 then generates an
assessment
of the risk 110 in the portfolio 104. In one embodiment, the engine 102 may
also receive
actual market data 106, real time or historical, to be factored into the risk
analysis. In one
embodiment, the-risk analysis engine 102 is the SPANO software published by
the
Chicago Mercantile Exchange Inc., located in Chicago, Illinois, described
above. The
portfolio 104, as described above, includes the positions, i.e. contracts,
options, etc., and
in particular, fixed-payoff contracts, for which the given entity has entered
into but not
closed out during a given trading period, i.e. the open positions, for a given
entity of
interest. The entity for which the portfolio applies may be a trader, a
brokerage house (all
of the traders affiliated therewith), or a clearing member, etc.
[00405] The parameter set 108, as described above, includes parameters, as
described above, which are determined by the entity performing the analysis to
reflect the
risk coverage desired in any particular market. These parameters 108 may
include, but
are not limited to:
- Price Scan Range: A set range of potential price changes;
- Volatility Scan Range: A set range of potential implied volatility changes;
- Intra commodity Spread Charge: An amount that accounts for risk (basis
risk) of calendar spreads or different expirations of the same product,
which are not perfectly correlated;
- Short Option Minimum: Minimum margin requirement for short option
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positions;
- Spot Charge: A charge that covers the increased risk of positions in
deliverable instruments near expiration; and
- Intercommodity Spread Credit: Margin credit for offsetting positions
between correlated products.
- Interexchange Spread Credit: Margin credit for offsetting positions
between correlated products traded at different exchanges, trading venues,
or trading events.
This parameter recognizes the potential risk-offset between similar
binary contracts traded at different venues as traders may trade
multiple events at different places. For example, a non-farm payroll
binary contract traded at CME vs the saine contract traded at
Chicago Board of Trade or trading World Series Winner with point
spreads at the Harrah's Las Vegas vs. trading at the Trump hotel
casino in Atlantic city, NJ.
[00406] In operation, as described above, the portfolio 104 and parameter set
108,
and possibly the marlcet data 106, are input into the engine 102. The engine
102
processes the data and generates the assessment 110. The engine 102 may
operate in
batch to process multiple portfolios, using the same or different parameter
sets
108/market data 106, or may process one portfolio at a time. As was described
above, the
engine 102 may be operated by a clearing house of an exchange to assess actual
required
performance bonds, or changes thereto. The engine 102 may also be operated by
entities
which are subject to such performance bonds in order to anticipate the
requirements of the
clearing house. Further, engine 102, as described below, provides accurate
determinations as to the risk in the portfolio 104 to ensure that the clearing
house is
adequately protected and that those subject to the bond requirements are not
unduly
burdened with unnecessary requirements.
[00407] In one embodiment, the engine 102 executes on a computer having a
Pentium-class processor, or suitable equivalent, a hard disk drive, for
example a hard disk
drive having a 10 gigabyte capacity, a memory, for example a memory having a 1
gigabyte capacity, and a suitable output device such as flat panel LCD
display. Further,
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the computer executes an appropriate operating system, such as Microsoft
Windows XP,
published by the Microsoft Corporation, located in Redmond, Washington. The
computer
system 102 fiuther may include a network interface and accompanying software
for
coupling the system with a network, the interface being of a suitable type for
the network,
such as an Ethernet or optical based network. The network may be a public or
private
network, such as the Internet, an intranet, a virtual private network, or
other TCP/IP or
non-TCP/IP based network as is known. Further, secure protocols, such as -
sHTTP or
encryption, may be included to protect communications from being intercepted
or
modified and to generally authenticate users and ensure secure operation. It
will be
appreciated that any suitable computer system having suitable processing,
storage and
communications capabilities may be used with the disclosed embodiments, such
as a
mainframe computer, a mini-computer, a workstation, a personal computer or a
personal
digital assistant. It will be further appreciated the disclosed embodiments
may be
executed on a single computer system or one or more the components may be
executed
on a computer system which separate from one or more computer system(s)
executing the
remaining of the components, and suitably interconnected, such as via a
network.
[00408] While the disclosed embodiments relate to a computer software program
which is stored in the meinory of a computer and executed by the processor(s)
of the
conlputer to perform the disclosed functions, it will be appreciated that one
or more of the
disclosed components may be implemented in hardware or a combination of
hardware
and software, and is implementation dependent.
[00409] As shown in Figure 2, in one embodiment, the engine 102 includes a
Possible Outcome Generator 206, a Probability Generator 208, coupled with the
Possible
Outcome Generator 206, a Risk Array Value Generator 210, coupled with the
Possible
Outcome Generator 206 and a Risk Array 214 coupled with the Risk Array Value
Generator 210. Further, a Processor 212 is coupled with Risk Array 214 and
further
receives data representing the portfolio 104 to be analyzed. As discussed
above, these
components may be implemented as one or more computer software/logic
programs/modules stored in a memory or computer storage device and executable
by a
computer processor to iinplement the disclosed functionality.
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[00410] The Possible Outcome Generator 206 receives data representing the
portfolio to be analyzed and computes all of the possible outcomes of the
various
products 204 held in the portfolio 104. In one embodiment, only outcomes of
significance are determined. In alternate embodiments, insignificant or all
outcomes,
whether possible or not, are determined, dependent upon the implementation.
For each
generated outcome, the Possible Outcome Generator 206 accesses the Probability
Generator 208 to determine the probability of the particular outcome
occurring. The
probability generator 208 may received parameter data from the parameters 108,
described above, as well as real time market data 106, to be utilized in the
computation of
the particular outcome probability. It will be appreciated that known
statistical principals
may be used in determining the requisite probabilities. Further, the
probability may be
determined as a statistically significant value or as a discount to be applied
to the
product's value for the given outcome.
[00411] The generated possible outcomes and associated probabilities are then
passed to the Risk Array Value Generator 210 which generates the data values
to populate
the Risk Array 214. These values may be expressed/represented as dollar values
of the
given contract at the given value and may be shown as negative numbers for
gains and
positive numbers for losses. The Risk Array 214 may be implemented as a flat-
file or
relational data base or other type of data structure which permits the
processor 212 to
access particular possible outcomes and retrieve associated probability or
adjusted
product values.
[00412] In one embodiment, the Possible Outcome Generator 206, Probability
Generator 208 and Risk Array Value Generator 210 generate the Risk Array 214
as
follows:
1. The Possible Outcome Generator 206 defmes a universe of
outcomes to check as follows:
a. For products which can only settle at strike level,
the outcomes are all defined strikes
b. For products that can settle between strikes,
the universe of outcomes includes all strikes plus:
i. Point one tick below lowest strike
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ii. Point one tick above highest strike
iii. One point in between each close pair of strikes
2. The Risk Array Value Generator 210 calculates, for each contract,
a risk array with number of points equal to the number of outcomes
defined at step 1 with each point corresponding to the profit/loss
for particular outcome adjusted for probability, provided by the
Probability Generator 208 and interest rate, provided as a
parameter 108.
Risk array points are defined by the Risk Array Value Generator
210 as follows:
a. For products which can only settle at strike level, risk array
points are every strike from lowest to highest
b. For products that can settle between strikes, iterate through
strikes starting with the lowest one adding following points
to risk array:
i. Point one tick below lowest strike
ii. Each strike
iii. Point one tick above each strike (if it is not equal to
the next strike)
For each contract, calculate risk array values for each risk array
Point as follows:
(Contract Value - Contract Payoff at this point discounted at
appropriate interest rate) * Probability weight
[00413] In the above described embodiment, the probability weights may be
determined as follows:
Weight is equal to 1 for all outcomes where it is desirable not to give any
discount due to low probability and less than 1 for other outcomes. There are
two
possible methods of maintaining probability weights:
1. Provide weights separately for every risk array point as part
of risk array point definitions. This is the most flexible way, but would
require a lot of
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maintenance especially in cases when new strikes could be added on the fly
thus changing
number of risk array points and requiring constant maintenance; or
2. Provide weights in "tiers" or for ranges of outcomes. For
example all outcomes between 100 and 200 would have a weight of 1 and from 200
and
higher - a weight of 0.9. This way requires less maintenance, but is a little
bit less
flexible.
[00414] The Processor 212, based on the products 204 contained within the
portfolio 104, determines the value of the combination of the products 204.
The total
value of the portfolio 104 may be computed as the summation of the values of
the
individual products 204, where the individual values may be computed as the
likelihood
of a payoff multiplied by the amount of the payoff. The likelihood of a payoff
of a given
product may be correlated with the price of the product. Where the
contract/product 204
is a sell, the value may be expressed as a negative, and for a buy, may be
expressed as a
positive number, for the purposes of summation.
[00415] The Processor 212 then accesses the Risk Array 214 to determine the
total
risk of the portfolio 104. The Processor 212 obtains the Risk Array 214 values
for each
possible outcome for each product 204 in the portfolio 104. Where there are
multiple
products 204, the Processor 212 sums the values for each product within each
outcome to
obtain a summed value for each outcome for the entire portfolio 104. The
Processor 212
then determines the outcome with the highest risk of loss. The Processor 212
then
subtracts the value of the outcome with the llighest risk of loss from the
portfolio 104
value determined above. This results in the total margin requirement for the
portfolio
104.
[00416] The total margin requirement computed by the processor 212 factors in
the
value paid by the trader for buy contracts, since the risk of loss is covered
by the premium
that they have already paid to the exchange, as well as the probability of
that loss, and
credits the trader when the probability of that loss is low. Further, for sell
contracts, the
margin required to cover the contract may be reduced based on the probability
of loss or
may be offset by the credits granted on other buy contracts also contained
within the
portfolio 104. In this way, the burden on the trader is reduced as the total
required margin
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for the portfolio 104 may be less than the total value of the portfolio 104 as
a more
accurate reflection of the actual risk involved.
[00417] Figure 3 shows a flow chart illustrating operation of a risk
management
system for managing risk, i.e. computing a margin requirement, associated with
a
portfolio, the portfolio comprising at least one product having an associated
fixed payoff
value based on an occurrence of one of at least two outcomes of an event. The
event may
include a change in numerical value, such as a change in dollar value, change
in number
of jobs added to the economy, or change in interest rate, etc. Each of the at
least two
outcomes includes a possible resultant numerical value, i.e. a prediction as
to what the
change or end result may actually be. As described above, the fixed payoff is
paid if the
change in numerical value is greater than a defined criteria, e.g. greater
than a specified
value, less than a defined criteria, within a range of defmed criteria, or
combinations
thereof. For binary events, there are only two outcomes, the event either
occurs or it does
not occur.
[00418] The system first computes a product value of each of the products 204
in
the portfolio 104 (Block 302). The portfolio may include one or more products
related to
one or more events andlor one or more outcomes of those events. The product
value may
be computed as the price of the product multiplied by the fixed payoff value
associated
therewith. In one embodiment, the product value is expressed as a positive
number for
products representing buy orders and a negative value for products
representing sell
orders. The product value may alternatively be computed as the probability of
the
occurrence of a particular outcome resulting in the fixed payoff associated
with the
product multiplied by that fixed payoff.
[00419] The system then determines, for each product 204 in the portfolio 104,
other outcomes, other than the outcomes specifically defined to cause the
fixed payoff,
that may occur for the event which affect the associated fixed payoff with
respect to the
other outcomes and which are not redundant in view of other of the other
outcomes
(Block 306). For example, one other outcome may include a numerical value one
increment, i.e. tick, below the lowest numerical value of the specifically
defined
outcomes, another outcome may include a numerical value one increment above
the
highest numerical value of the specifically defined outcomes, and yet another
outcome
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may include a numerical value between the numerical values of two of the
specifically
defmed outcomes where those two outcomes are close. These outcomes represent
transitions in the payoff occurrences. Redundant outcomes, the transition to
which from
an included outcome doesn't change the payoff, are not included. In the case
of a binary
event, the specifically defined outcomes are the occurrence and non-occurrence
of the
event and, therefore, there are no other outcomes to be considered.
[00420] The system then generates, for each product 204 in the portfolio 104,
an
array defining a risk value for each of the outcomes defined above, the risk
value being a
representation of a gain or loss of the product value associated with the
particular
outcome (Block 310). In one embodiment, as described above, the risk value is
computed
as the product value minus the fixed payoff for the particular outcome.
[00421] The system then adjusts each of the risk values based on a discount
related
to the likelihood of occurrence of the associated outcome (Block 314). In one
embodiment, one or more of the risk values may not be discounted. As described
above,
this discount may computed based on a probability of occurrence of the
outcome. The
system may compute a probability/discount individually for each outcome, or
may group
the outcomes and compute the probability/discount for the group.
[00422] The system then determines, for all of the outcomes, an aggregate risk
value of the risk values for each product 204 in the portfolio 104 for the
particular
outcome (Block 318). In one embodiment, the risk values for a given outcome
across all
of the products 204 in the portfolio 104 are summed. This results in an
aggregate risk
value for each outcome.
[00423] The system then determines a maximum aggregate risk value comprising
the aggregate risk value representing the largest loss from among the
aggregate risk
values for each of the outcomes (Block 322). In situations where the there are
no
outcomes with losses, the maximum aggregate risk value would be zero,
reflecting that
there is no potential loss and that a margin amount should not be required.
The system
then computes a margin requirement equal to the difference between the product
value
and the maximum aggregate risk value. (Block 326)
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[00424] One implementation of the disclosed embodiments may utilize the SPAN
Risk Management System described above. In such a implementation, the risk
parameter
file format may be modified to accommodate the necessary parameters. For
example:
= New product type "BIN" may be introduced for those products (this affects
virtually all record types in the risk parameter file)
= New field may be added to the type "P" record to store a flag ("Y" or "N")
to tell
user whether underlying can settle between strikes or only at exact strikes
= New field may be added to the type "P" record to store tick size.
= On the type "B" record there is existing field for interest rate which may
be used
to specify interest rate for discounting contract payoff.
= New record type "85" may be created for specifying individual contracts.
Those
records will not hold risk arrays:
Table: Type "85 record - Binary contract record - Expanded Format
Length To Datatype Format Description
and
Comments
2 1 2 AN X(2) Record ID -
3 3 5 AN X(3) Exchange
Acronym
6 15 AN X(10) Commodity
(Product)
Code
10 16 25 AN X(10) Underlying
Commodity
(Product)
Code
3 26 28 AN X(3) Product
Type Code
1 29 29 AN X Option Right
Code for
Strike 1
6 30 35 N 9(6) Futures
Contract
Month as
CCYYMM
2 36 37 AN X(2) Futures
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Contract
Day or
Week Code
1 38 38 - - Filler
6 39 44 N 9(6) Option
Contract
Month as
CCYYMM
2 45 46 AN X(2) Option
Contract
Day or
Week Code
1 47 47 - - Filler
7 48 54 N 9(7) Strike Price
1
1 55 55 AN X Simple vs.
Range flag
1 56 56 AN X Option Right
Code for
Strike 2
7 57 63 N 9(7) Strike Price
2
7 64 70 N 9(7) Payoff
amount
39 70 110 - - Filler
7 111 117 N 9(7) Settlement
Price
1 118 118 AN X Sign for
Settlement
Price (blank,
"+" or "")
1 119 119 AN X Sign for
Strike Price
1 (blank, "+"
or
1 120 120 AN X Sign for
Strike Price
2 (blank, "+"
or "-")
[00425] Where:
= Strike Price 1 is a strike price or low boundary for ranges
= Option Right Code for Strike (1 or 2) - can take following values:
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o A - equal (_)
o Z - not equal (<>)
o C - greater(>)
o P-less(<)
o D - greater or equal (>_)
o Q - less or equal (<=)
= Simple vs. Range flag - "Y" means that this is a range and second strike is
defined, blank or "N" means that this is a binary or "all or nothing" and
there is no second
strike
= Strike Price 2 is an upper boundary for ranges
= Payoff amount - is an amount of payoff expressed in the same terms as
settlement price (settlement price decimal locator needs to be applied and
result needs to
be inultiplied by contract value factor)
= New type "86" record may be created for specifying risk arrays for
individual
contracts.
= New type "Q " record may be created to store probability weight tiers
[00426] Implications for positions file format:
In positions file format a new record type may be added to support two strikes
and
relationship for each strike (record type "6").
However if all contracts within a series have different lower boundary strike
(
strike) logic may be implemented in PC-SPAN to recognize positions specified
using
existing position record types ("3" and "5").
[00427] It will be appreciated that the above described exemplary file
structure may
vary based upon the implementation of the disclosed system and method.
[00428] In one embodiment, the system and method may work as shown in the
following examples, these examples using non-farm payroll data as an exemplary
basis of
the contracts contained within the portfolio 104.
[00429] Assumptions made for the following examples:
Each option has a fixed payoff of $1000;
Call pays if actual payroll number is greater than or equal to strike. Put
pays if payroll number is less than strike;
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Expectation is of a non-farm payroll number to be 200,000 increase;
Contract can settle between strikes. Tick size is 1;
No different probabilities for "out of the money" strikes.
Strike Call Price Put Price Call Put Value
Value
-100 0.98 0.02 980 20
0 0.90 0.10 900 100
100 0.72 0.28 720 280
200 0.50 0.50 500 500
300 0.30 0.70 300 700
400 0.10 0.90 100 900
[00430] Risk Array 214, as deterniined by the Possible Outcome Generator 206,
Probability Generator 208 and Risk Array Value Generator 210, for all strikes
(positive
numbers are losses, negative numbers are gains) - in these examples, there is
no discount
for low probabilities:
Scenarios:
Strike -101 -100 -99 0 1 100 101
-100 Call 980.00 -20.00 -20.00 -20.00 -20.00 -20.00 -20.00
-100 Put -980.00 20.00 20.00 20.00 20.00 20.00 20.00
0 Call 900.00 900.00 900.00 -100.00 -100.00 -100.00 -100.00
0 Put -900.00 -900.00 -900.00 100.00 100.00 100.00 100.00
100 Call 720.00 720.00 720.00 720.00 720.00 -280.00 -280.00
100 Put -720.00 -720.00 -720.00 -720.00 -720.00 280.00 280.00
200 Call 500.00 500.00 500.00 500.00 500.00 500.00 500.00
200 Put -500.00 -500.00 -500.00 -500.00 -500.00 -500.00 -500.00
300 Call 300.00 300.00 300.00 300.00 300.00 300.00 300.00
300 Put -300.00 -300.00 -300.00 -300.00 -300.00 -300.00 -300.00
400 Call 100.00 100.00 100.00 100.00 100.00 100.00 100.00
400 Put -100.00 -100.00 -100.00 -100.00 -100.00 -100.00 -100.00
Scenarios
Strike 200 201 300 301 400 401
-100 Call -20.00 -20.00 -20.00 -20.00 -20.00 -20.00
-100 Put 20.00 20.00 20.00 20.00 20.00 20.00
0 Call -100.00 -100.00 -100.00 -100.00 -100.00 -100.00
0 Put 100.00 100.00 100.00 100.00 100.00 100.00
100 Call -280.00 -280.00 -280.00 -280.00 -280.00 -280.00
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100 Put 280.00 280.00 280.00 280.00 280.00 280.00
200 Call -500.00 -500.00 -500.00 -500.00 -500.00 -500.00
200 Put 500.00 500.00 500.00 500.00 500.00 500.00
300 Call 300.00 300.00 -700.00 -700.00 -700.00 -700.00
300 Put -300.00 -300.00 700.00 700.00 700.00 700.00
400 Call 100.00 100.00 100.00 100.00 -900.00 -900.00
400 Put -100.00 -100.00 -100.00 -100.00 900.00 900.00
[00431] Example 1: Portfolio 104 contains Buy one contract of 100 Call at .72:
Value of portfolio 104 as computed by the Processor 212 =$720;
Margin (also referred to as the SPAN Risk), as computed by the Processor 212,
would be $720 (excluding any Net Option Value ("NOV")), i.e. this is the
maximum loss
the portfolio could have; and
Total margin requirement (also referred to as the SPAN total margin
requirement
)(counting NOV) computed by the Processor 212 according to the disclosed
system and
method=$720- $720=$0.
[00432] Example 2: Portfolio 104 contains: Sell one contract of 300 Put at.70:
Value of portfolio 104 = -$700;
SPAN Risk would be $300 (excluding any NOV);
SPAN total margin requirement (counting NOV) = $300 + $700 = $1000.
[00433] Example 3: Portfolio 104 contains: Sell one contract of 100 put at.28.
Sell
one contract of 200 put at .50:
Value of portfolio 104 = -$280 - $500 = -$780
Total Risk:
1220.00 11220.00 11220.00 11220.00 11220.00 220.00 220.00
1 -780.00 I -780.00 I -780.00 I -780.00 I -780.00 I -780.00
SPAN Risk would be $1220 (excluding any NOV).
SPAN total margin requirement (counting NOV) = $1220 + $780 = $2000.
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[00434] Example 4: Portfolio 104 contains: Sell one contract of 100 call
at.72, Sell
one contract of 0 put at.10, Buy one contract of 200 call at.50, Sell on
contract of 300
put at .70:
Value of portfolio 104 = -$720 -$100 + $500 - $700 = -$1020
Total Risk:
980.00 980.00 980.00 -20.00 I -20.00 980.00 980.00
-20.00 -20.00 -1020.00 -1020.00 -1020.00 -1020.00
SPAN Risk would be $980 (excluding any NOV).
SPAN total margin requirement (counting NOV) = $980 + $1020 = $2000.
[00435] The following examples change the assumption about no discount for low
probabilities.
Assume that discount for -100 and below and 400 and above is 20%; and
Assume that discount for 0 and below and 300 and below is 10%.
[00436] Rislc Array 214 for all strikes (positive nlunbers are losses,
negative
numbers are gains):
Weights:
0.8 0.8 0.9 0.9 1 1 1
Scenarios:
Strike -101 -100 -99 0 1 100 101
-100 Call 784.00 -16.00 -18.00 -18.00 -20.00 -20.00 -20.00
-100 Put -784.00 16.00 18.00 18.00 20.00 20.00 20.00
0 Call 720.00 720.00 810.00 -90.00 -100.00 -100.00 -100.00
0 Put -720.00 -720.00 -810.00 90.00 100.00 100.00 100.00
100 Call 576.00 576.00 648.00 648.00 720.00 -280.00 -280.00
100 Put -576.00 -576.00 -648.00 -648.00 -720.00 280.00 280.00
200 Call 400.00 400.00 450.00 450.00 500.00 500.00 500.00
200 Put -400.00 -400.00 -450.00 -450.00 -500.00 -500.00 -500.00
300 Call 240.00 240.00 270.00 270.00 300.00 300.00 300.00
300 Put -240.00 -240.00 -270.00 -270.00 -300.00 -300.00 -300.00
400 Call 80.00 80.00 90.00 90.00 100.00 100.00 100.00
400 Put -80.00 -80.00 -90.00 -90.00 -100.00 -100.00 -100.00
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Weights
1 1 0.9 0.9 0.8 0.8
Scenarios
Strike 200 201 300 301 400 401
-100 Call -20.00 -20.00 -18.00 -18.00 -16.00 -16.00
-100 Put 20.00 20.00 18.00 18.00 16.00 16.00
0 Call -100.00 -100.00 -90.00 -90.00 -80.00 -80.00
0 Put 100.00 100.00 90.00 90.00 80.00 80.00
100 Call -280.00 -280.00 -252.00 -252.00 -224.00 -224.00
100 Put 280.00 280.00 252.00 252.00 224.00 224.00
200 Call -500.00 -500.00 -450.00 -450.00 -400.00 -400.00
200 Put 500.00 500.00 450.00 450.00 400.00 400.00
300 Call 300.00 300.00 -630.00 -630.00 -560.00 -560.00
300 Put -300.00 -300.00 630.00 630.00 560.00 560.00
400 Call 100.00 100.00 90.00 90.00 -720.00 -720.00
400 Put -100.00 -100.00 1 -90.00 -90.00 720.00 720.00
[00437] Example 5: Portfolio 104 contains: Buy one contract of 0 Call at.90:
Value of portfolio 104 = $900;
Margin (SPAN Risk) would be $810 (excluding any NOV); and
SPAN total margin requirement (counting NOV) = $810 - $900 = -$90
This means that there is $90 excess value which could be available to offset
margin requirements in other products)
[00438] Example 6: Portfolio 104 contains: Sell one contract of 300 Call
at.30:
Value of portfolio 104 = -$300;
SPAN Risk would be $630 (excluding any NOV); and
SPAN total margin requirement (counting NOV) = $630 + $300 = $930.
[00439] Example 7: Portfolio 104 contains: Sell one contract of 0 put at.10,
Sell
one contract of 200 put at .50:
Value of portfolio 104 = -$100 - $500 = -$600;
Total Rislc:
1120.00 1120.00 1260.00 360.00 400.00 400.00 400.00
1 -600.00 -600.00 -540.00 -540.00 I -480.00 I -480.00
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SPAN Risk would be $1260 (excluding any NOV); and
SPAN total margin requirement (counting NOV) = $1260 + $600 = $1860.
[00440] Example 8: Portfolio 104 contains: Sell one contract of 100 call
at.72, Sell
one contract of 0 put at .10, Buy one contract of 200 call at .50, Sell on
contract of 300
put at .70:
Value of portfolio = -$720 -$100 + $500 - $700 = -$1020;
Total Risk:
784.00 784.00 882.00 -18.00 I -20.00 980.00 980.00
1 -20.00 -20.00 -918.00 I -918.00 -816.00 -816.00
SPAN Risk would be $980 (excluding any NOV); and
SPAN total margin required (counting NOV) = $980 + $1020 = $2000.
[00441] It is therefore intended that the foregoing detailed description be
regarded
as illustrative rather than limiting, and that it be understood that it is the
following claims,
including all equivalents, that are intended to define the spirit and scope of
this invention.
